Mellon v. Commissioner

A. W. MELLON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. 1

Mellon v. Commissioner

Docket No. 76499.

United States Board of Tax Appeals

36 B.T.A. 977 ; 1937 BTA LEXIS 628 ;

December 7, 1937 , Promulgated

*628 1. The sale by petitioner of stock of the Pittsburgh Coal Co. to the Union Trust Co. of Pittsburgh was a complete and valid sale, giving rise to a legal deduction.

2. Respondent disallowed a deduction claimed on account of loss on sale of stock of the Western Public Service Corporation, on the ground that "the disposal of these stocks do not appear to be transactions on which losses may be recognized for income tax purposes." Petitioner in his petition affirmatively alleged that petitioner did not, within "thirty days before or after the date of such sales, enter into any contract or option to purchase or acquire any shares of the said stock of said corporation." The evidence shows that the stock was reacquired 37 days after the sale but does not establish when the contract to reacquire was entered into. Held, the petitioner had the burden of proving no contract or option was entered into within thirty days of the sale. The deduction is disallowed for failure of such proof.

3. Sales of stock by petitioner to a corporation, all of the stock of which was owned by his daughter, were valid sales and, under the law as it existed in 1931, gave rise to legal deductions.

*629 4. Petitioner did not file a false and fraudulent return with intention to evade taxes.

5. Petitioner was not, in 1931, the owner of any bank stocks.

6. In the summer of 1930 the Bethlehem Steel Corporation began negotiations with the McClintic-Marshall Corporation for the acquisition of approximately one-third of the assets of the latter. After terms were generally agreed on the two corporations instructed their attorneys to draw the contracts so as to prevent, if possible, the recognition of gain to McClintic-Marshall or its stockholders. Under the plan of procedure worked out McClintic-Marshall on January 15 transferred the assets omitted from the Bethlehem transaction to the Union Construction Co., a new corporation, for 4,990 of its total 5,000 shares of authorized stock, which stock was issued directly to the stockholders of the McClintic-Marshall Corporation. On February 10, 1931, the McClintic-Marshall Corporation transferred to assets covered by its agreement with the Bethlehem Steel Corporation to three of the latter's subsidiary corporations for 240,000 shares of the common stock of the Bethlehem Steel Corporation and $8,200,000, face value, of its bonds, the *630 said stock and bonds being distributed directly to the stockholders of the McClintic-Marshall Corporation. Held, that the Bethlehem Steel Corporation did not acquire substantially all of the assets of the McClintic-Marshall Corporation so as to constitute the transaction a reorganization within the meaning of section 112(i)(1)(A) of the Revenue Act of 1928; held, further, that the Bethlehem Steel Corporation was not a corporation a party to a reorganization and the gain to the petitioner on the distribution to him of the Bethlehem stock and bonds is to be recognized. Groman v. Commissioner, 302 U.S. 82 .

7. Though the Union Construction Co.-Koppers Co. reorganization, the Union Construction Co.-Pitt Securities Corporation reorganization, and the Pitt Securities Corporation liquidation were parts in a single plan for the liquidation of Union, the successive distributions by Union to its stockholders of the stock of Koppers and Pitt were distributions within section 112(g) and the basis of petitioner's Union stock is to be apportioned among Koppers, Pitt, and Union in determining the gain to petitioner from the liquidation of Union. Rudolph Boehringer, 29 B.T.A. 8 , *631 and North American Utility Securities Corporation, 36 B.T.A. 320 , followed.

8. Certain payments by the Union Construction Co. and Pitt Securities Corporation for the account of petitioner held to be dividends.

9. The fair market value of the stock of the McClintic-Marshall Construction Co. on March 1, 1913, determined to $300be per share.

10. The A. W. Mellon Educational and Charitable Trust was, in 1931, a valid existing trust, organized and operated exclusively for educational and charitable purposes. The transfer by petitioner to the trust of certain paintings in 1931 was a complete and valid gift.

Frank J. Hogan, Esq., William A. Seifert, Esq., Maynard Teall, Esq., Paul G. Rodewald, Esq., W. W. Booth, Esq., Nelson T. Hartson, Esq., Donald D. Shepard, Esq., and A. G. Wallerstedt, Esq., for the petitioner.

Robert H. Jackson, Esq., F. R. Shearer, Esq., David R. Shelton, Esq., and E. L. Updike, Esq., for the respondent.

VAN FOSSAN

*978 The respondent determined a deficiency in petitioner's income tax for the calendar year 1931 in the amount of $1,319,080.90, together with a penalty of 50 percent under *632 section 293(b) of the Revenue Act of 1928. Petitioner filed his petition with the Board asking redetermination of the deficiency, denying fraud, and claiming an overpayment in the amount $139,045.17. By his answer, as amended, respondent asserted an increased deficiency in the amount of $2,059,507.49, plus a penalty of 50 percent, or a total deficiency in tax and penalty of $3,089,261.24.

The several issues involved in the case have been grouped as follows in the findings of fact, and, with the exception of the issue as to *979 the McClintic-Marshall-Bethlehem reorganization, will be considered in the opinion in the order indicated:

I. The stock sales and the charge of fraud. II. The ownership of the bank stocks. III. The McClintic-Marshall Corporation-Bethlehem Steel Corporation transaction. IV. The liquidation of Union Construction Co. V. The payments by Union Construction Co. and Pitt Securities Corporation for the account of petitioner. VI. The valuation of the stock of McClintic-Marshall Construction Co. VII. The contributions issue. FINDINGS OF FACT.

I. - The Stock Sales.

Pittsburgh Coal Co. Stock. - On December 30, 1931, petitioner *633 was the owner of 123,622 shares of the common stock of the Pittsburgh Coal Co., all but 125 shares of which had been owned by him for more than two years prior to 1931. Of the total of 123,622 shares of Pittsburgh Coal Co. stock, 76,822 shares which had been carried in the "Joint Account" of A. W. and R. B. Mellon were transferred to the personal account of petitioner on December 30, 1931, and showed a cost of $3,863,777.75. The total cost to petitioner of the 123,622 shares was $6,177,847.75.

During the year 1931 petitioner had realized large capital gains. Sometime in December of that year he discussed with H. M. Johnson, his financial secretary, the matter of his income tax return and which securities might best be sold to establish capital losses with the purpose of claiming such losses as deductions in his return. Petitioner determined that the common stock of the Pittsburgh Coal Co. would be the most suitable for the purpose.

Petitioner accordingly approached H. G. McEldowney, president of the Union Trust Co. of Pittsburgh (hereinafter called the Union Trust Co.), and proposed a sale to the Union Trust Co. of the above mentioned block of common stock of the Pittsburgh *634 Coal Co. McEldowney inquired the amount of the stock and the price. Upon being informed of the number of shares and that the price was $500,000 for the block, McEldowney told petitioner to send the stock over and the Union Trust Co. would take it.

Petitioner thereupon directed Johnson to gather together the certificates representing his common stock holdings in the Pittsburgh Coal Co. and deliver them to the Union Trust Co. On December 30, 1931, Johnson delivered certificates representing 123,622 shares of common stock of the Pittsburgh Coal Co. to the Union Trust Co. and received therefor the check of that company for $500,000. *980 The Union Trust Co. issued a formal confirmation of the transaction, as follows:

THE UNION TRUST COMPANY OF PITTSBURGH

Pittsburgh, Pennsylvania

Date Ded. 30, 1931

Purchased from A. W. Mellon,

c/o H. M. Johnson,

Mellon National Bank,

No. P. 65234 Fifth Ave. and Smithfield Street,

Pittsburgh, Pennsylvania

IN Account Quantity Description Price Amount

123,622 shares PITTSBURGH COAL COMPANY COMMON CAPITAL STOCK ( $100. PAR VALUE) 4.0445875 $500,000.00

Settlement Date Dec. 30, 1931. M

We *635 are pleased to confirm purchase from you of the within described securities. Payment will be made on above settlement date, to which time interest has been calculated. Securities should be in our possession on that date, when interest thereon will cease.

Upon receipt of the Pittsburgh Coal Co. stock the Union Trust Co. had the shares transferred to the name of Acly Co., a partnership composed of certain officers of the Union Trust Co., which had been formed for the purpose of holding title to securities owned by the Union Trust Co. and to facilitate their transfer on disposition but which, in 1931, held title to securities representing the investment account, the trading account, the trust department, the loan department, and securities held for customers. The officers of the Union Trust Co. had also formed a second partnership called Clay & Co., to hold title to securities held for customers. At that time the Union Trust Co. had no Pittsburgh Coal Co. common stock among its investments and the name of that stock was not printed on its investment sheet forms. It was, however, listed by typewriter on the investment lists issued during the period the stock was held by the Union *636 Trust Co.

In accordance with instructions previously received from petitioner, Johnson, after receipt of the check for $500,000 from the Union Trust Co., drew a check on petitioner's personal account payable to the Union Trust Co. for a similar amount and delivered that check on December 30, 1931, as a payment on petitioner's note for $1,000,000 held by that company.

Petitioner never reacquired any part of such stock and thereafter never owned any common stock of the Pittsburgh Coal Co.

*981 Toward the end of March or during the first part of April 1932, McEldowney issued instructions to Carl R. Korb, a vice president of the Union Trust Co., to dispose of the 123,622 shares of common stock of the Pittsburgh Coal Co., acquired as above indicated, if and when a fair return on the investment of the Union Trust Co. therein could be secured. On or about the date of receiving this instruction, Korb approached Johnson, the petitioner's secretary, and inquired about a possible purchaser. Johnson advised him that he knew of no one interested at that time. Korb made no further inquiries and did not look elsewhere for a purchaser. Later in the month of April, he made a similar *637 inquiry Of Johnson and Johnson asked Korb to quote a price. Korb had a memorandum prepared which read as follows;

Figured for April 25, 1932.

A. W. MELLON Dec. 30, 1931, 123,622 shares Pittsburgh Coal Company Common stock ( $100 par value) at 4.0445875 $500,000.00

Cost $500,000.00

Interest - 118 days at 6% 9,833.33

Stock Transfer Stamps 4,944.88

Penna. Five Mill Tax 2,500.00

$517,278.21

Average price figured on $517,278.21 $4,18435399

Upon being advised of the price, Johnson told Korb that the price was all right and that the stock would be purchased by the Coalesced Co. Up to that time Korb was not advised as to the name of the party represented by Johnson in making the purchase.

At 2 p.m. on the same date a special meeting of the board of directors of the Coalesced Co. was held, at which the following resolution was adopted:

RESOLVED:

That the proper officers of the Company purchase from the Union Trust Company of Pittsburgh 123,622 shares of the common capital stock of the Pittsburgh Coal Company at $4.18435399 a share, for the account of the Coalesced Company; that in effecting the purchase of said stock they pay to the said, *638 the Union Trust Company of Pittsburgh $117,278.21 out of funds of the Corporation, and that they give the Union Trust Company the Company's note for $400,000; and that in connection with giving the note for the purchase of said stock that said officers give the necessary stock powers and that they arrange from time to time for the reduction of said not out of funds of the Corporation, and arrange for the renewal of the note.

The stock was paid for by check of the Coalesced Co. also dated April 25, 1932, in the amount of $517,278.21 drawn on funds provided as shown in the resolution. As collateral for the $400,000 note, the *982 Coalesced Co. deposited the Pittsburgh Coal Co. common stock so acquired. Within a few days, at the request of the Union Trust Co., it deposited as further collateral Republic of Poland bonds having $500,000 par value.

The Union Trust Co. issued a formal confirmation of sale to the Coalesced Co. as follows:

THE UNION TRUST COMPANY OF PITTSBURGH

Pittsburgh, Pennsylvania.

Date Apr. 25, 1932

Sold to The Coalesced Company

Box 1139,

Pittsburgh, Pa.

In Account

No. S106917 Quantity Description Price Amount

123,622 shares PITTSBURGH COAL COMPANY COMMON STOCK ( $100 PAR VALUE) 4 18435399 FLAT $517,278.21

Settlement Date Apr. 25, 1932 KORB

*639 We are pleased to confirm sale to you of the within described securities. Payment is due on the above settlement date, to which time interest has been calculated. If unable to call on settlement date, please forward check and securities will be held for your convenience or shipped as desired. If payment is delayed, interest to date of payment will be charged. Kindly advise disposition of securities, if you have not already done so. We appreciate this business and thank you for it.

At the time of the sale of the stock to the Coalesced Co. petitioner was in England. He had no knowledge of the sale until his return to the United States in July 1932.

The Coalesced Co. was organized by petitioner on December 2, 1929, under the laws of Delaware. Its authorized stock was of one class and consisted of 300,000 shares of no par value stock. The petitioner was originally the sole stockholder, having received 94,460 shares of the said stock in exchange for securities and real estate as follows: Securities and other property Cost or other basis to petitioner Value at which taken on books of Coalesced Co.

1,500 shares Montreal Light, Heating & Power, Consolidated $2,500.00 $171,000.00

4,940 shares of Shawinigan Water & Power Co 171,201.96 395,440.00

102,904 shares of Aluminum, Ltd 804,594.00 1,434,232.00

Lots 5, 80, and 81, East Liberty, Pa 99,085.00 182,000.00

30 shares Sparks Supply Co 3,000.00 3,000.00

31,386 shares U.S. Steel Corporation 2,847,865.90 5,115,918.00

*640 *983 On December 18, 1931, the Coalesced Co. was reorganized with authorized capital stock of 250,000 shares of $100 par value preferred stock and 250,000 shares of $1 par value common stock. Two hundred thousand shares of preferred stock and 200,000 shares of the common stock were issued to the petitioner in exchange for the original stock of the Coalesced Co. and additional securities as follows: Securities and other property Cost or other basis to petitioner Value at which taken on books of Coalesced Co.

100,000 shares Aluminum Co. of America, preferred stock $3,783,961.20 $6,500,000.00

50,000 shares Aluminum Co. of America, preferred stock 1,891,980.50 3,250,000.00

450,000 shares Gulf Oil Corporation 7,517,322.80 12,150,000.00

100,000 shares Carborundum Co 1,038,094.00 6,500,000.00

2,500 shares Clay District Coal Co 5,687,396.22 5,687,396.22

550,000 shares Gulf Oil Corporation 9,187,851.20 14,850,000.00

500,000 shares Koppers Co. common stock 1,175,341.52 7,500,000.00

$500,000 par value 7% Republic of Poland bonds 452,500.00 257,500.00

Singer-Mashey Real estate, Pittsburgh 331,307.05 331,307.05

1,500 shares Wharton Coal Co 1,660,382.48 1,660,382.48

*641 The above securities were taken upon the books of Coalesced Co. at their fair market value, as determined by the officers of Coalesced Co. On December 31, 1931, the balance sheet of the Coalesced Co. showed assets aggregating $61,978,686. Of this amount $61,055,184.70 represented securities received from petitioner.

At various times prior to, during and subsequent to the taxable year petitioner made large gifts of securities and other property to his two children, Ailsa Mellon Bruce, wife of David K. E. Bruce, and Paul Mellon.

On December 25, 1931, the petitioner made a gift of all of the common stock of the Coalesced Co. to his children, Ailsa and Paul, giving to each 100,000 shares. With the stock the petitioner sent the following letter to his daughter, Ailsa Mellon Bruce:

DECEMBER 25th, 1931.

DEAR AILSA: In the past from time to time I have transferred to you and to Paul as gifts certain investments, chiefly in properties with the management or control of which I have in the past been long associated, and as you both with David are becoming interested and acquainted with these businesses and taking care of your and my interests to my satisfaction and gratification, *642 I am now at Christmas time transferring to you and to Paul each of you one hundred thousand (100,000) shares of the common capital stock of The Coalesced Company which company holds and owns stock and securities largely of the same companies in which you are already interested as you know from your acquaintance with the company and the information I have given you concerning it and the properties.

With best wishes to you and for a most enjoyable Christmas and with much love,

Your affectionate father,

*984 A letter of similar purport was written to Paul Mellon.

The petitioner has owned no common stock of the Coalesced Co. since December 25, 1931, but has continued to own the preferred stock. The preferred stock is entitled to a 6 percent dividend per annum out of the net assets of the corporation in excess of its capital and out of its net profits, payable quarterly, and is subject to redemption at any quarterly dividend date at $105 per share plus accrued dividends. The common stock has all voting rights unless dividends on the preferred remain unpaid for four quarterly dividend dates, whether or not successive, in which case voting powers vest exclusively in the *643 preferred. No dividends can be paid on the common stock unless the dividends accrued on the preferred are paid and then only by making certain prescribed provisions for the redemption of preferred stock. During the year 1932 the Coalesced Co. paid only one quarterly dividend on the preferred stock of $300,000, and that was paid in cash. In 1933 it paid two quarterly dividends amounting to $600,000 in cash and gave demand notes for the balance of the accumulated dividends for 1932 and 1933. Its earnings were not sufficient to pay the dividends in cash.

After the transfer of securities made at the time of reorganization, up to the close of the year 1933, the Coalesced Co. acquired additional securities which were taken upon its books at approximately $31,600,000. Substantially all of these securities were acquired from Ailsa Mellon Bruce and Paul Mellon, after they had been received as gifts from the petitioner, or were securities which had been sold by the petitioner at a loss, either to the Union Trust Co. or through the brokerage firm of Moore, Leonard & Lynch. In some instances the Coalesced Co. placed matched orders for the securities sold by petitioner through Moore, Leonard *644 & Lynch.

The officers of the Coalesced Co. from January 14, 1931, to May 29, 1933, were as follows:

President - Henry A. Phillips, senior employee of the A. W. and R. B. Mellon Joint Account.

Vice president - Paul Mellon, son of petitioner. Secretary and assistant treasurer - D. D. Shepard, petitioner's personal attorney.

Treasurer and assistant secretary - H. M. Johnson, petitioner's financial secretary.

On May 29, 1933, Ailsa Mellon Bruce resigned from the board of directors and her husband, David K. E. Bruce, was elected in her place. At a special meeting of the board of directors on May 31, 1933, Paul Mellon was elected president and Bruce was elected vice president. During the years 1931 and 1932 the Coalesced Co. paid no salaries to its officers.

The capital stock of the Pittsburgh Coal Co. was divided into two classes, 400,000 shares of common stock and 350,000 shares of 6 percent *985 cumulative preferred stock, both having a par value of $100 per share. The preferred stock shares with the common in the earnings of the company after the payment of a 6 percent dividend on both classes of stock. It also had equal voting rights with the common stock. *645 The stock of the company is listed on both the New York and Pittsburgh Stock Exchanges. During the year 1930 the total sales of the common stock on the Exchanges amounted to 52,100 shares at prices ranging from a high of 78 1/2 per share in January to a low of 17 1/2 per share in December. In 1931 similar sales amounted to 29,100 shares at prices ranging from a high of 28 1/2 in January to a low of 4 in December. During the month of December 1931, a total of 2,900 shares were sold on the Exchanges, the highest price paid being 6 7/8. On December 28, 100 shares sold at 4 1/4. No sales occurred on December 29. The bid and asked prices on that date were 4 and 4 1/4, respectively; on December 30, 200 shares at 4. In April 1932, 500 shares were sold at prices ranging from a high of 4 3/4 to a low of 3 7/8. On April 23, the last business date preceding that on which the Coalesced Co. acquired the stock from the Union Trust Co., 3 7/8 was the bid price and 4 was the asked price. In May the Exchange prices ranged from a high of 6 to a low of 3, with 400 shares sold. In June 700 shares were sold at prices ranging from 3 to 3 1/2.

At December 30, 1931, the Pittsburgh Coal Co. had *646 paid no dividends on its common stock for a number of years because of lack of earnings. For the same reason the dividends on preferred stock had not been paid in full, and on the date mentioned the accrued but unpaid dividends on preferred stock had reached such a large aggregate per share that the common stock had no prospects as a dividend producer. Its value was speculative. The petitioner's block of 123,622 shares was the largest single block of Pittsburgh Coal Co. stock outstanding and its value lay largely in the strategic position of the holder for voting purposes.

On March 23, 1932, the petitioner gave 34,000 shares of preferred stock of the Pittsburgh Coal Co. to his son and daughter jointly. They immediately contributed the said stock to the Coalesced Co.

The Union Trust Co. was originally formed as a companion company of the Fidelity Title & Trust Co. of Pittsburgh, the purpose being to create a second company which could legally indulge in business matters connected with the affairs of trusts and estates for which the Fidelity Title & Trust Co. was acting. The petitioner became its first president. Shortly thereafter, various investors in the Union Trust Co. *647 became dissatisfied with the earnings of the company, and the petitioner advocated the opening of banking offices and the entry of the company into a general banking business. This course was *986 opposed by certain of the officers, and petitioner agreed to purchase the stock of all of those who had become dissatisfied. As a result his stockholdings in the Union Trust Co. were substantially increased. About 1898 James A. McKain, the president of the Union Trust Co., died and, at petitioner's insistence and over the protest of numerous officers and stockholders, H. C. McEldowney was named president, in which capacity he continued until his death in 1935. At the time McEldowney was named president of the Union Trust Co. he was assistant cashier of the National Bank of Commerce in Pittsburgh. During the years 1931 and 1932 R. B. Mellon, the petitioner's brother, was a vice president and director of the Union Trust Co. and was also a member of its executive committee. Richard K. Mellon and W. L. Mellon, nephews of the petitioner, were members of the board of directors during the same period, and in 1932 petitioner's son, Paul Mellon, was also elected to membership. A large *648 number of the remaining members of the board were, and had been, closely associated with petitioner in the operation and management of the various business corporations in which petitioner had his chief interests.

In 1869 petitioner's father, Thomas Mellon, established the banking house of T. Mellon & Sons. Upon completion of his studies at the University of Pittsburgh, petitioner went immediately into the bank as an employee. A few months later the father gave petitioner a one-fifth interest in the business of the bank. Some time later Thomas Mellon wrote and signed the following letter:

PITTSBURGH, January 5, 1882.

Proposition to son Andrew for services past, and future.

He to have the entire net profits of the Bank from January 1, 1881, including my salary. The books to be readjusted accordingly. From 1st January instant. He to have entire net profits of bank and pay me an annual salary of two thousand dollars as its attorney and fifteen hundred per annum rent for the banking room; and I to allow him forty-five hundred per annum for attending to my private affairs and estate, selling lots, collecting rents, a/c as done heretofore.

This arrangement to last *649 till superseded by another or annuled by either party.

After a few years petitioner made a gift to his brother, R. B. Mellon, of a half interest in the bank, the business being thereafter carried on as a partnership under the name of T. Mellon & Sons. No writing evidencing the gift was executed.

In 1902 the Mellon National Bank was organized and acquired in exchange for its capital stock the private banking business of the partnership. Petitioner and his brother, R. B. Mellon, immediately exchanged the stock so received for stock of the Union Trust Co. The latter company has continued as the owner of 98 percent or more of the stock of the Mellon National Bank down to the present date. Upon its organization the petitioner became the president of the *987 Mellon National Bank and continued to serve in that capacity until shortly before he became Secretary of the Treasury on March 4, 1921.

In December of 1932 petitioner had under discussion with Johnson the matter of his income tax return for that year, and Johnson presented a list of securities and recommended their sale. Petitioner directled that they be sold. On December 29, 1932, Johnson having first discussed *650 the matter with H. C. McEldowney, delivered the securities to Carl R. Korb, a vice president of the Union Trust Co. Korb took the matter up with McEldowney and was told that he had agreed to purchase the securities at the market. Korb accepted delivery of the certificates and issued formal confirmation of the purchases and delivered Union Trust Co. checks covering the purchase price.

In February 1933 Korb received instructions from McEldowney to dispose of the securities acquired from the petitioner in December. The instructions were to sell at the market price. Korb called Johnson and made inquiries about a purchaser. Johnson asked that he quote him a price. On receiving the quotations from Korb, Johnson objected to the price at which 40,000 shares of American Locomotive Co. common stock were quoted. These shares had been price at $200,000 in the December transaction, but were quoted by Korb at $240,000. Johnson agreed to pay $215,000, or 5-3/8 per share, instead of $6 per share, the price at which the shares were then quoted on the Exchange. After consultation with McEldowney, Korb was instructed to accept Johnson's proposal. As a result the entire block of securities *651 in question was sold to the Coalesced Co. under date of February 28, 1933, for a total sum of $318,859.63. Part of the purchase price of the securities was paid by the Coalesced Co. out of funds then on hand, while the remainder was paid from the proceeds of a loan from the Union Trust Co. in the amount of $218,859.63. The securities acquired were posted as collateral. The prices received by the petitioner from the Union Trust Co. in December, the prices paid to the Union Trust Co. by the Coalesced Co. in February, and the amount at which the securities in question were taken by the Union Trust Co. as collateral for the Coalesced Co.'s loan, are shown as follows: Name of security Price paid to petitioner by Union Trust Co. Price paid to Union Trust Co. by Coalesced Co. Value as collateral to loan from Union Trust Co.

40,000 shares of American Locomotive Co., common $200,000.00 $215,000.00 $240,000.00

5,500 shares Missouri Pacific R.R. Co., preferred 19,937.50 19,250.00 16,500.00

6,500 shares United Porto Rican Sugar Co., preferred 6,500.00 6,500.00 No value.

$208,000 par value United Porto Rican Sugar Co. gold notes 10,400.00 8,320.00 4,160.00

$219,000 par value Missouri Pacific R.R. Co. gold bonds 1 16,698.75 1 13,687.50 13,140.00

1,250 shares Aluminum Co. of America, preferred 50,000.00 52,187.50 50,000.00

*652

*988 The 1,250 shares of Aluminum Co. of America preferred stock represented 1,000 shares belonging to Paul Mellon and 250 shares belonging to his mother.

All of the securities included in the above transaction were listed securities except the Sugar Co. stocks. At the time of the transaction with the Union Trust Co. on December 29, 1932, the United Porto Rican Sugar Co. gold notes were indefault.

In December of 1933, Johnson again conferred with petitioner in regard to the sale of certain securities then on hand. The securities selected were $247,000 par value German Government external 7 percent bonds due in 1949; $33,000 par value Aluminum Limited 5 percent bonds due in 1948; $196,000 par value Interboro Rapid Transit 5 percent bonds due in 1966; $17,000 par value B & O. convertible 4 1/2 percent bonds due in 1960. Johnson advised the petitioner that it had been agreed by the directors of the Coalesced Co. that that company could use the securities in question, and after some discussion it was agreed that the petitioner should sell the bonds in question through the brokerage firm of Moore, Leonard & Lynch and that a matched order *653 to buy the bonds should be placed with the same firm at the same price on behalf of the Coalesced Co.

Accordingly, on December 28, 1933, the bonds were sold through Moore, Leonard & Lynch for the petitioner and at the same time purchased through the same firm for the Coalesced Co. The petitioner sustained a loss on the transaction in the amount of $63,533.23. The bonds were delivered to the brokerage firm by Scott and Wynkoop, the former being an employee of petitioner and the latter an employee of Coalesced Co. The same bonds were delivered by the brokers to Scott and Wynkoop for delivery to the Coalesced Co.

All of the securities acquired by the Coalesced Co. during the years 1931, 1932, and 1933 from the Union Trust Co. were securities which petitioner had sold to the Union Trust Co. at a loss, preliminary to the preparation of his income tax return for the year or years in which the transaction with the Union Trust Co. occurred, except the block of 1,250 shares of Aluminum Co. of America preferred stock, which had belonged to Paul Mellon and his mother and which had been included with the securities transferred by petitioner to the Union Trust Co. on December 29, 1932.

*654 Over a period of years prior to the incorporation of the Mellon National Bank, and independent of the banking business, petitioner and his brother, R. B. Mellon, had invested jointly in real estate and in large amounts of securities. The records of these investments were kept in a set of books referred to as the "Joint Account" and, prior to the incorporation of the bank, specifically designated as "A. W. Mellon & R. B. Mellon." After the incorporation of the bank the Joint Account was known as "T. Mellon & Sons" until March 1, *989 1918, when the following memorandum of agreement was entered into between petitioner and R. B. Mellon:

WHEREAS, A. W. MELLON and R. B. MELLON have, for many years past, owned jointly certain real estate, stocks, bonds and other securities, and interests in real estate, the same being enumerated in the Schedule hereto annexed, and, for their own convenience in handling such investment, they have adopted and used the name of T. MELLON & SONS, under which name the properties have been carried; and

WHEREAS, the understanding between the parties respecting their interests in said properties is evidenced only by the books of account, which have *655 been kept respecting the same, and they are desirous now by written agreement, of evidencing the arrangement under which said properties are owned, their respective interests therein, and also changing the name used to identify said accounts from T. Mellon & Sons to A. W. Mellon & R. B. Mellon, so as to avoid any significance of partnership liability, obligation or power.

NOW, THEREFORE, it is agreed between the parties as follows:

(1) The moneys with which to acquire a part of the said properties having been advanced in unequal proportions by the respective parties, the understanding has been and is that, in the joint account, credit shall be given to each of the parties for their respective individual advancements of moneys to the purposes of the joint account, and interest shall be allowed thereon in accordance with the practice heretofore existing.

(2) Additional properties may be purchased and added to said joint account by the concurrence of both parties hereto, and in like manner further advancements for the purpose of making such purchases, or for the protection of any investment carried in said joint account may be made by either party hereto, and the same shall be *656 added to and treated in the same manner as advancements heretofore made.

(3) The properties so owned jointly and the income therefrom shall be liable for the re-payment to the parties respectively of all such advancements, together with interest; and also for the payment or performance of all obligations incurred by the parties hereto in connection with the properties so owned jointly. For the purpose of securing such repayment and performance, all shares of stock and securities so owned jointly shall be kept separate and apart from the other securities and properties owned by the parties hereto, and shall be placed in the custody of such party or parties as may, from time to time, be mutually arranged by the parties hereto, and all shares of stock, securities and properties belonging to said joint account shall be deemed charged with a lien and pledged to secure the payment to the parties of their respective advancements (with interest) and the payment or performance of the other obligations mentioned.

(4) For the convenience of the parties the custody and handling all of said properties so owned shall be carried on in the names of the parties hereto, jointly, viz: A. W. Mellon *657 and R. B. Mellon.

(5) It is distinctly stipulated and agreed that the arrangement heretofore existing and now defined by this present agreement exists entirely for the convenience of the parties, shall not constitute a partnership, shall not be deemed to give to either party the powers of a partner nor authorize the carrying on of any trade or business, but the relation is limited strictly to the custody, protection and handling of the properties herein mentioned, owned jointly by the parties hereto, and their respective rights therein.

(6) Subject to the payment to the respective parties of their advancements (with interest) as above mentioned, the interest of the parties in the said properties *990 and the income and proceeds thereof is an undivided one-half interest to each of said parties.

WITNESS the due execution hereof this 1st day of March, 1918.

After the execution of the above agreement, petitioner and his brother continued as theretofore to invest equally in real estate and various securities. At no time did they engage in business as dealers. Title to real estate was carried in a single name for convenience while securities were carried in the name *658 of petitioner and his brother, separately, one-half in the name of each, or in the names of their nominees. In making purchases or sales for the Joint Account the interest of each owner was indicated. The bank account of the Joint Account was carried in both names. Petitioner and his brother each gave the other a written plenary power of attorney and both names were used in executing necessary documents.

The certificates representing securities carried in the Joint Account were, so far as possible, equally divided, one-half to each, petitioner and R. B. Mellon, and placed in two separate pouches marked with the initials of the respective owner, the pouches both being kept in a safety deposit box held in the name of A. W. & R. B. Mellon. When money was required it wa supplied one-half by each owner. At the end of each year statements were prepared and furnished the owners showing all receipts and expenditures and the holdings of each owner in the Joint Account. If either petitioner or his brother borrowed from the Joint Account, interest was charged on such loan.

During the taxable year the Joint Account was largely managed by R. B. Mellon through H. A. Phillips, an employee, *659 who acted under a power of attorney.

No partnership returns were ever filed as to the Joint Account, and petitioner and his brother, each in his individual return, reported half the income and claimed deductions of half the expenses and half the losses arising from the transactions carried in the Joint Account.

The relationship between A. W. Mellon and R. B. Mellon, evidenced by the Joint Account, was not a partnership.

In his tax return for 1931 petitioner deducted as a capital loss the sum of $5,672,189.95, and as an ordinary loss the sum of $5,766.30 on account of the above described sale of common stock of the Pittsburgh Coal Co. Respondent disallowed the deductions, assigning as a reason that "the disposal of these stocks do not appear to be transactions on which losses may be recognized for income tax purposes." In his answer in this proceeding respondent charged that the above sale was fraudulent.

The sale by petitioner of 123,622 shares of the common stock of the Pittsburgh Coal Co. was a completed valid sale.

Western Public Service Corporation Stock. - In December 1928 petitioner and his brother, R. B. Mellon, by subscription each acquired *991 *660 7,500 shares of stock in the Western Public Service Corporation at $15 per share, or at a cost to petitioner of $112,500, a check for $225,000 on the Joint Account being given to cover the purchases of both. In February 1929 petitioner and his brother each acquired from the Union Trust Co. 20,000 shares of Western Public Service Corporation at $22 per share, or at a cost to petitioner of $440,000. On December 12, 1930, petitioner and his brother each acquired, by subscription, 4,500 additional shares at $15 per share, or at a cost to petitioner of $67,500. Payment was made through the Joint Account in each instance and thereafter the securities were carried in such account, one-half in the name of each, the petitioner and his brother. The total cost to petitioner of the 32,000 shares thus acquired was $620,000. Thereafter petitioner and his brother each disposed of 5,000 shares out of those purchased in February 1929 to various of their employees at cost, leaving 27,000 shares owned by each on December 2, 1931.

On December 2, 1931, R. B. Mellon, acting for himself and his brother, petitioner here, sold the 54,000 shares of Western Public Service Corporation stock to the Union *661 Trust Co. for $4 per share, or a total of $216,000. The transaction was arranged with H. C. McEldowney. The delivery of the stock was made to S. S. Liggett, a vice president of the Union Trust Co. The Trust Co. issued formal confirmation of the purchase. The check for the purchase price was deposited in the Joint Account of A. W. and R. B. Mellon.

The Western Public Service Corporation common stock was listed on the Pittsburgh Stock Exchange and during 1931 the total sales amounted to 247,000 shares, ranging from a high of 14 1/2 to a low of 2 1/8 per share. In December 54,595 shares were sold at prices ranging from 4 1/2 per share down to 2 7/8. During the first four days of December, a total of 8,140 shares were sold at prices ranging from 4 3/8 per share to a low of 4. In January 1932, 6,310 shares were sold at prices ranging from a high of 4 1/2 to a low of 3 1/4 per share. In February, 4,727 shares were sold at prices ranging from a high of $5 per share to a low of $4.

On January 8, 1932, R. B. Mellon, acting for himself and his brother, purchased 54,000 shares of Western Public Service Corporation stock from the Union Trust Co., paying $4.075 per share, or $220,050 *662 for the lot. The check in payment was drawn on the Joint Account.

Thereafter the stock was placed in the Joint Account, being held 27,000 shares in the name of H. A. Phillips and 27,000 shares in the name of J. F. Sturgeon. Phillips and Sturgeon were employees and nominees of petitioner and his brother, in whose names stocks were often held.

*992 As to 4,500 shares purchased December 12, 1930, at a cost of $67,500 and sold for $18,000, petitioner, in his return for 1931, claimed an ordinary loss of $49,500. As to the remainder, 22,500 shares, having a cost to him of $442,500, he claimed a capital loss of $352,500. Respondent disallowed the losses claimed, assigning the same reason as in the case of the stock of Pittsburgh Coal Co., "the disposal of these stocks do not appear to be transactions on which losses may be recognized for income tax purposes." In his answer in this proceeding respondent charged that the sale was fraudulent.

Both at the time of the sale to the Union Trust Co. and of the sale by the Union Trust Co., R. B. Mellon was a vice president of the Union Trust Co. He was also a director and member of the executive committee of the Union Trust Co. *663 and, as such, was present at the meetings of each body when approval of the above transactions was voted.

In at least four or five other instances the Union Trust Co. bought securities and between thirty and ninety days thereafter sold them back to the person from whom it had purchased them. This usually occurred in the months of December and January. The above transaction involving Western Public Service Corporation stock is the only instance in the record in which R. B. Mellon, acting for petitioner, sold stock to the Union Trust Co. and, after the expiration of 30 days, purchased the same, or substantially identical, property.

R. B. Mellon had full authority to act on behalf of petitioner in the above transaction, but petitioner had no personal knowledge of the sale or purchase until 1933, when his 1931 tax return was being questioned.

The sale by R. B. Mellon, acting for petitioner and himself, of 54,000 shares of the stock of Western Public Service Corporation was a valid legal sale.

Sales to the Ascalot Co. - On December 1, 1931, petitioner owned 6,200 shares of American Locomotive Co. stock acquired by purchase in 1930 and 1931 at a cost of $230,292.50; 3,900 *664 shares of Texas Gulf Sulphur Co. stock acquired by purchase in 1930 at a cost of $209,420; 1,900 shares of United Light & Power Co. preferred stock acquired by purchase, 1,400 shares on November 7, 1929, at a cost of $131,780, and 500 shares on November 14, 1930, at a cost of $49,100; and 2,500 shares of Westinghouse Electric & Manufacturing Co. stock acquired by purchase in May 1931 at a cost of $153,212.50. The aggregate cost of all the above stock was $773,805.

*993 On December 1, 1931, petitioner sold the above shares of stock to the Ascalot Co. at the following prices: 6,200 shares American Locomotive $49,600

3,900 shares Texas Gulf Sulphur 100,400

500 shares United Light & Power 25,000

1,400 shares United Light & Power 70,000

2,500 shares Westinghouse Electric & Mfg 82,500

Total 328,500

The prices at which the above stocks were sold were, in each instance, the fair market price of the stock on the date of sale.

The losses so sustained were claimed by petitioner as deductions in his 1931 tax return. These deductions were disallowed by respondent and in his answer it is charged that the sales were fraudulent. In his brief and on oral *665 argument respondent abandoned the charge of fraud as to these transactions with the Ascalot Co.

The Ascalot Co. was incorporated under the laws of Delaware on July 11, 1930, with an authorized issue of 2,000 shares of stock of an aggregate par value of $200,000. On July 12, 1930, Ailsa Mellon Bruce, daughter of petitioner, exchanged securities having a face value of approximately $7,000,000 for all of the capital stock of the Ascalot Co. At all times since organization Ailsa Mellon Bruce has been the sole stockholder in the Ascalot Co. At various other times she contributed other securities to the company, substantially all of the securities so contributed having come into her possession as gifts from petitioner. A relatively small number were acquired by purchase.

At the organization meeting the following were elected directors and officers:

D. K. E. Bruce, president Paul Mellon, vice president

Ailsa Mellon Bruce, treasurer

H. M. Johnson, assistant treasurer D. D. Shepard, secretary On January 21, 1931, H. A. Phillips was elected assistant secretary. The executive committee consisted of Bruce, Johnson, and Shepard.

Petitioner has never owned any stock, nor *666 been an officer or director, nor had any part in the direction or management of the Ascalot Co.

All of the earnings of the Ascalot Co. have been absorbed by its sole stockholder, Ailsa Mellon Bruce.

Petitioner entered into no contract or option with 30 days before or after the sale on December 1, 1931, to reacquire any of the above *994 mentioned stocks and never reacquired any interest in the American Locomotive, Texas Gulf Sulphur, or United Light & Power stocks. On July 1, 1933, petitioner bought from the Ascalot Co. at the then market price, 2,500 shares of Westinghouse Electric & Manufacturing Co. stock, paying $118,125 therefor, this sale resulting in a profit of $35,725 to the Ascalot Co. Petitioner still owns the Westinghouse stock then acquired.

The above sales by petitioner of stock of the American Locomotive Co., Texas Gulf Sulphur Co., United Light & Power Co., and Westinghouse Electric & Manufacturing Co. to the Ascalot Co. were valid and bona fide sales.

II. - The Ownership of the Bank Stocks.

On March 4, 1921, petitioner became Secretary of the Treasury of the United States. On or about January 25, 1921, petitioner was advised by counsel that, *667 as a prerequisite to accepting the above position, by virtue of which he would become, ex officio, chairman of the Federal Reserve Board, it would be necessary for him to divest himself of the ownership of all bank stocks. At that time he was the owner of a large block of stock of the Union Trust Co. and lesser amounts of stock in other banks. On February 7, 1921, petitioner purchased 82 shares of stock of the Union Trust Co. at a price of $2,750 per share. These shares had formerly been owned by the estate of H. C. Frick. At the same time petitioner's brother, R. B. Mellon, bought 185 shares of the same stock. The two purchases brought petitioner's holdings in stock of the Union Trust Co. to 3,300 shares and those of R. B. Mellon to 1,000 shares.

On March 1, 1921, petitioner and his brother, R. B. Mellon, executed a contract of sale in the following form:

AGREEMENT, Made this first day of March, A.D. 1921, between ANDREW W. MELLON, of the City of Pittsburgh, Pennsylvania, of the first part, and RICHARD B. MELLON, of the same City, of the second part:

WITNESSETH:

That the first party hereby sells to the second party for the consideration hereinafter set forth, the *668 following shares of stock in the several corporations enumerated, and for the prices per share set opposite to each block of stocks, as shown in an exhibit hereto attached initialed by the parties hereto.

The second party agrees to pay to the first party the several amounts set opposite each block of stock, aggregating the total sum of Ten million, five hundred twenty thousand, four hundred ninety five and no one-hundredths ($10,520,495.00) Dollars, in six months after demand for such payment by said first party, or his legal representatives, and to pay interest thereon at the rate of five and one-third per centum, annually, in quarterly installments.

As there are accruing upon said shares dividends maturing and payable at different dates, therefore, for expediency, it is agreed that the first party shall be paid the accruing dividend when paid by each of the said companies, and *995 interest upon the portion of the purchase price represented by said block of stock shall begin to run from the date of payment of said dividend.

Payments may be made by the second party on account of the principal debt at any time prior to the demand for payment as aforesaid.

The certificates *669 for said shares of stock shall be transferred upon the books of the companies to said second party, shall by him be endorsed in blank, in due form, and shall be deposited with the Union Trust Company of Pittsburgh, as custodian, to secure the payment of the consideration, under an authority, duly executed by both parties, reciting the trust under which said shares are held.

It is further agreed between the parties that in the event of the death or legal disability of the first party before payment of the consideration, the second party may relieve himself of the obligation of this agreement by returning the said shares of stock to the legal representatives of the first party and adjusting the unpaid interest and accruing dividends, and thereupon the obligation of the second party under this agreement shall be terminated, except for an adjustment of interest and dividends accruing.

It is further agreed between the parties hereto that in the event of the death or legal disability of the second party, his legal representatives may in like manner terminate this agreement by delivering the certificates of stock to the first party, or his legal representatives, and thereupon the obligation *670 of the second party shall be terminated, except for an adjustment of interest and dividends accruing.

It is further agreed between the parties hereto that in the event of the death or legal disability of the second party, the first party, or his legal representatives, shall have the option to terminate this agreement by re-taking the shares of stock hereinbefore set forth and delivering an acquittance to the second party's legal representatives of obligation for the purchase money aforesaid, due adjustment being made between interest unpaid and accruing dividends.

Witness: [Signed] A. W. MELLON

[Signed] H. M. JOHNSON R. B. MELLON

There was appended a list showing the number of shares, the price per share, the selling price of each stock, and the aggregate selling price of the entire list of stocks in 24 banks.

On the same date there was executed between petitioner, his brother, and the Union Trust Co. an agreement providing for the deposit of the stocks sold with the Union Trust Co. as custodian and agent of petitioner, the Union Trust Co. to hold the stock as pledge and security for the payment of the principal and interest provided in the agreement above referred *671 to. The certificates were to be endorsed in blank. The agreement provided for the sale of the security in event of default of payment of principal or interest and the accounting for the proceeds. It also provided for the release of any part of the stock on written notice by petitioner and his brother.

The two above agreements were drawn by counsel for petitioner and R. B. Mellon and were prepared after a proposed plan of exchanging the bank stocks for other types of stocks was abandoned due to the difficulty of fixing the exchange value of the other stocks.

After the agreements were executed appropriate entries were made *996 in the books of the parties reflecting a sale and purchase. In petitioner's books these entries were made in the "R. B. Mellon" account. Entries were likewise made from time to time thereafter in R. B. Mellon's books to reflect interest paid to petitioner and dividends received by R. B. Mellon, and in petitioner's books to record interest received.

In his tax return for 1921 petitioner reported gains and losses arising from the sale of the bank stocks covered by the agreement of March 1, 1921, the net result being a loss of $23,805.83. Upon *672 audit by the Bureau of Internal Revenue various changes were made, resulting in a net profit from the March 1, 1921, transaction of $206,325. This adjustment, with others made in the 1921 return, resulted in an additional tax of $132,836.21, which was paid by petitioner.

On April 1, 1927, the dividend rate on stock of the Union Trust Co. was increased from 35 percent to 50 percent. Shortly thereafter, without petitioner's knowledge, petitioner's financial secretary suggested to R. B. Mellon that the interest rate provided by the agreement for sale of the bank stocks should be increased. R. B. Mellon agreed to the proposal and the interest rate was changed from 5 1/3 percent to 7 percent, effective July 1, 1927. In the year 1929 the interest rate was increased from 7 percent to 8 percent, effective April 1, 1929.

At various times petitioner loaned R. B. Mellon money to make investments and for other business purposes. The amounts of such loans were charged to the R. B. Mellon account in petitioner's books and subsequent repayments were there credited. During the period from 1921 to 1930 R. B. Mellon used some of the money thus borrowed to purchase additional bank stocks. *673 The stocks so purchased were deposited with the trustee as collateral under the agreement of March 1, 1921. Other amounts loaned were used to purchase additional stock upon the exercise of stock rights, such new stock being deposited as additional collateral. New stock arising from stock dividends on the stock so held was likewise deposited.

Under date of June 20, 1930, petitioner, R. B. Mellon, Paul Mellon, and the Union Trust Co. executed an agreement by the terms of which R. B. Mellon sold, assigned, and transferred to Paul Mellon all his rights under the two agreements of March 1, 1921, and in and to all securities subject to such agreements. Paul Mellon, on his part, assumed all the obligations and liabilities of R. B. Mellon under such agreements, including the obligation to pay the purchase price of $10,520,495, with interest thereon. Petitioner consented to the assignment and transfer and acknowledged receipt of all interest due to date from R. B. Mellon. The substitution of Paul Mellon for *997 R. B. Mellon in the indebtedness was made at the request of R. B. Mellon.

Appropriate book entries were made in petitioner's accounts to reflect the release of R. *674 B. Mellon from the obligation and the assumption thereof by Paul Mellon. On the same day, June 20, 1930, Paul Mellon was charged and R. B. Mellon credited with two items, one of $253,000, a second of $17,900, on account of funds loaned by petitioner to R. B. Mellon, such funds having been used to acquire additional bank stocks and the loans being unpaid. Under date of July 2, 1930, R. B. Mellon paid the sum of $351,346.46, which amount was entered on petitioner's books as "Interest - final payment." With the payment of this sum the amounts received by R. B. Mellon as dividends and the amounts paid to petitioner as interest were brought into exact balance. The payment was made without the knowledge of petitioner and arose from the desire of R. B. Mellon not to profit by the 1921 transaction.

After June 20, 1930, Paul Mellon paid petitioner interest on the obligation at the rate of 7 percent. All dividends paid during 1931 were paid to Paul Mellon and accounted for by him in his tax return. All interest received by petitioner, in the taxable year and prior years, was returned by him for taxation. No demand was ever made for payment of the principal sum nor was any payment on *675 account thereof made.

On March 23, 1932, petitioner, by an instrument in writing, forgave Paul Mellon all indebtedness owed by him to petitioner excepting the sum of $2,000,000 which was to be represented by 40 promissory notes. The notes, bearing the above date, consisted of two series, the first of 20 notes of $45,000 each and the second of 20 notes for $55,000 each, all maturing quarterly. Appropriate entries were made to reflect the forgiveness of the debt in the amount of $8,791,395 and the conversion of the remaining indebtedness into serial notes.

On March 25, 1932, Paul Mellon caused a corporation, named Smithfield Securities Corporation, to be organized under the laws of Delaware. He transferred to this corporation all of the bank stocks owned by him, excepting 1,300 shares of the Union Trust Co., in consideration for 1,000 shares of stock of the Smithfield Securities Corporation. A short time later, acting on petitioner's suggestion, Paul Mellon gave his sister, Ailsa Mellon Bruce, one-half of the 1,000 shares owned by him in the Smithfield Securities Corporation. Thereafter Paul Mellon and his sister each exchanged the 500 shares of Smithfield for 10,000 shares *676 each of Coalesced common stock. On May 10, 1932, petitioner transferred to his children, Paul and Ailsa, as a gift an account receivable of $1,250,000 owed to him by R. B. Mellon. They immediately contributed the same to Smithfield.

*998 Petitioner has never been a stockholder, officer, or director in the Smithfield Securities Corporation.

On April 4, 1932, Paul Mellon paid petitioner $250,000, an amount sufficient to equalize the difference between the dividends received by him on the bank stocks and the interest paid to petitioner. This payment was made voluntarily and without the personal knowledge of petitioner. The payment was entered on petitioner's books as "Interest in full to 3/23/32" and reported by petitioner in his 1932 tax return.

On January 30, 1933, Paul Mellon filed a claim for refund of taxes paid for the taxable year 1931, in which he asserted that he had erroneously failed to claim deductions on account of the worthlessness of certain bank stocks owned by him in that year. The claim was allowed in part and rejected in part. A certificate of overassessment for $375 was issued and paid, with interest of $32.86. The stock as to which the certificate *677 of overassessment was issued consisted of 12 1/2 shares of the Farmers & Merchants Bank of West Newton, Pennsylvania, acquired by Paul Mellon by the transaction of June 20, 1930.

By amendment of his answer respondent alleged in effect that in 1931 petitioner was the owner of the above bank stocks; that he received, actually or constructively, dividends in the amount of $804,466; that he did not report such sum as dividends but reported the sum of $755,397.64 thereof as interest received; that petitioner was entitled to a deduction which he did not claim on account of the worthlessness of the stock of the Farmers & Merchants Bank in the amount of $1,875; that accordingly he understated his income in the amount of $47,193.36.

During the taxable year 1931 petitioner was not the owner of the bank stocks listed in the contract of March 1, 1921.

III. - The McClintic-Marshall Corporation - Bethlehem Steel Corporation Transaction.

The McClintic-Marshall Construction Co. was incorporated under the laws of Pennsylvania, on March 20, 1900, for the purpose of engaging in the business of fabricating and erecting structural steel, a business commonly referred to hereinafter as the *678 fabricating business. Its incorporators were A. W. Mellon, R. B. Mellon, H. H. McClintic, and C. D. Marshall. On March 1, 1913, the corporation had outstanding 30,600 shares of common stock and 3,791 shares of preferred stock, of which the petitioner owned 9,030 and 600 shares, respectively. On December 8, 1921, a 100 percent dividend was declared on both the common and preferred stock, increasing the stock of the petitioner to 18,060 shares of common stock and 1,200 shares of preferred stock.

*999 On December 14, 1922, a dividend of 3,885 shares of preferred stock was declared on the outstanding common stock. On the 18,060 shares of common stock then held by him, the petitioner received 1,147 shares of the preferred stock so distributed. It is stipulated by the parties that, solely for the purpose of apportioning the basis of petitioner's 18,060 shares of common stock between those shares and the 1,147 shares of preferred stock on the date of distribution of the latter and wholly without prejudice to the right of either party to prove or contend otherwise in any other proceeding or for any other purpose in this proceeding, the 18,060 shares of common stock and the 1,147 *679 shares of preferred stock had a fair market value of the same amount per share and that accordingly the correct amount of petitioner's basis prior to the distribution of the 1,147 shares of preferred stock for determining gain or loss upon the subsequent sale or other disposition of the shares of common stock is to be apportioned between the 1,147 shares of preferred stock and the 18,060 shares of common stock in the proportion of 5.97178 per centum and 94.02822 per centum, respectively.

For a number of years the McClintic-Marshall Construction Co., commonly referred to hereafter as the Construction Co., operated its business directly. Later, however, its operations were carried on to a large degree through subsidiary companies which it had acquired or organized. In the course of its operations it had accumulated substantial properties and assets not used directly in the fabricating business. These assets included corporate stocks and bonds, accounts with various corporations, and cash. Some of the securities had been acquired as compensation for work done under various construction contracts.

In the annual report of C. D. Marshall to the stockholders of the Construction *680 Co., under date of February 24, 1920, the following statement appears: "As a number of our investments do not have any direct bearing on the manufacturing operation of the McClintic-Marshall Construction Company, and the Riter-Conley Manufacturing Company, I recommend that the following investments be sold at actual cost to the McClintic-Marshall Corporation, to be organized as a holding company, and for the purpose of taking care of investments that it may be to our interest to acquire in the future." The stocks of five companies were listed at a cost or value totaling $5,667,104.

The McClintic-Marshall Corporation, hereinafter referred to as McClintic-Marshall, was organized under the laws of Delaware on December 24, 1926. It issued its capital stock, both common and preferred, on December 29, 1926, to the respective holders of the common and preferred stock of the McClintic-Marshall Construction Co., share *1000 for share, the petitioner receiving for his stock in the Construction Co. 18,060 shares of common stock and 2,347 shares of preferred stock of McClintic-Marshall. The preferred stock was 6 percent participating stock. On December 21, 1928, at an adjourned meeting *681 of the stockholders, the certificate of incorporation was amended so as to provide for two issues of preferred stock. The preferred stock then outstanding constituted the first issue and was subject to redemption at the option of the company at $100 per share, or book value if the book value exceeded that amount. The second issue was 6 percent nonparticipating stock and was redeemable at the option of the company at $105 per share.

Shortly after the amendment of the certificate of incorporation the preferred stock outstanding, all first issue stock, was called for redemption at $323.21 per share, represented by the company to be the book value. In the alternative the holders of preferred shares outstanding were given the privilege of exchanging their shares for preferred shares of the second issue, at the rate of 3.2321 new shares for each of the old shares. All of the preferred stockholders accepted the offer and made the exchange, except the estate of George W. Corbett, owner of 500 shares. Instead of surrendering the stock in accordance with the call, the estate instituted suit in a chancery court in Delaware alleging that the call price fixed by the board of directors did *682 not truly reflect book value, that if the assets were properly shown on the books the book value of the stock would be at least $1,250 per share, and praying that McClintic-Marshall be required to prepare and file a true and correct statement of assets and liabilities and that a decree be entered establishing the proper redemption price. This suit was pending throughout the year 1930 and was not settled until July 22, 1931.

The petitioner exercised the option to exchange his preferred stock of the first issue for preferred stock of the second issue and received 7,585 shares of the latter. In late December 1930 or in January 1931, he acquired by purchase from McClintic-Marshall 131 additional shares of the second issue, at a cost of $130 per share.

Upon its organization in 1926, McClintic-Marshall acquired from the Construction Co. the stock of its operating subsidiaries. It also acquired all other assets of the Construction Co., including the securities and assets not directly used in the fabricating business, except such properties as were retained by the Construction Co. for direct operation. At June 30, 1930, McClintic-Marshall owned the stock of sixteen companies, including *683 operating companies, to the extent of 100 percent.

Along in June or July of 1930, Eugene G. Grace, president of the Bethlehem Steel Corporation, hereinafter referred to as Bethlehem, suggested to C. D. Marshall, chairman of the board of directors of the *1001 McClintic-Marshall Corporation, the idea of the acquisition by Bethlehem of the fabricating business and the assets connected therewith of the McClintic-Marshall Corporation and its subsidiaries. Bethlehem owned directly and indirectly the stocks of a large group of affiliated corporations, sixty or more in 1931, carrying on various businesses such as coal mining, iron mining, the manufacture, production, and fabricating of steel and steel products, transportation, and shipbuilding. At that time the fabricating business of the Bethlehem group was third in size in the United States and it was the desire of Bethlehem to expand that business by the acquisition of the fabricating business and assets of McClintic-Marshall. There was no suggestion or desire on the part of Grace for the acquisition of what may be termed as the investment or nonfabricating assets of McClintic-Marshall. The discussions continued from time *684 to time during the summer of 1930 and as the result of a meeting held at Bethlehem, Pennsylvania, in August, Price, Waterhouse & Co. was instructed to make an examination of the books and accounts of McClintic-Marshall and its subsidiaries and to prepare a consolidated statement of the assets and liabilities of the group as at June 30, 1930, and a consolidated profit and loss statement for the three years ended December 31, 1929, and the six months ended June 30, 1930. This examination and report was to be made for the purpose of supplying data from which a figure might be obtained at which Bethlehem would acquire and McClintic-Marshall would dispose of the fabricating business and assets.

The original report was submitted under date of September 13, 1930, and supplemental reports were made under dates of September 17 and 25 and October 6, 1930. The examinations made and the reports submitted did not cover the assets and liabilities or the profits and losses of the subsidiary and affiliated companies in which Bethlehem was not interested. Certain other assets, including investments in stocks and bonds, advances to subsidiary or affiliated companies, th income therefrom, and the *685 related items of expenses were also excluded from the examinations and reports.

Before the end of October 1930, it was understood in general terms that Bethlehem or nominees, subject to the drafting of the contracts and the working out of the details of the transaction, would acquire the fabricating business and the assets connected therewith of McClintic-Marshall and its subsidiary companies and would pay therefor 240,000 shares of Bethlehem common stock and $8,200,000, face value, of Bethlehem 4 1/2 percent serial gold bonds and would assume the liabilities properly allocable to the fabricating business of McClintic-Marshall and its subsidiaries and an outstanding $12,000,000 bond issue of the McClintic-Marshall Construction Co. It was also agreed that McClintic-Marshall should have the dividends *1002 and interest on the Bethlehem stock and bonds from October 1, 1930. After the general understanding was reached in October of 1930, the attorneys for the parties were instructed to prepare the necessary contracts. They were further instructed to prepare the contracts in such a way, if possible, as to avoid any tax to McClintic-Marshall or its stockholders.

It was the *686 understanding that pending the drafting of the contracts there should be no changes in the business and assets of McClintic-Marshall except such changes as should take place in the ordinary course of business. At some date prior to December 5, 1930, however, representatives of McClintic-Marshall stated to Bethlehem that it was advisable for "Pennsylvania tax reasons" to retain Pennsylvania real estate of substantial value and suggested that a parcel of real estate owned by the Kenilworth Land Co. in the city of Pittsburgh and known as the Water Street property was most suitable for that purpose. It was proposed that this property be conveyed to McClintic-Marshall and cash in an amount equivalent to its value substituted among the assets Bethlehem was to receive.

The plan of procedure originally contemplated was that the McClintic-Marshall Corporation should transfer that portion of its assets which Bethlehem was to acquire to a new corporation in exchange for the capital stock of the new corporation and the new corporation would then transfer the assets so received to Bethlehem for the consideration which had been agreed upon, and immediately thereafter would distribute the Bethlehem *687 stock and bonds so received to its stockholders and be dissolved.

On the 27th day of October 1930, the Union Construction Co., sometimes referred to as Union, was organized under the laws of Delaware as the new corporation to be used in effecting the transfer of the fabricating business and assets, under the agreement with Bethlehem. Its authorized capital stock was 50 shares, which had a par value of $100 per share. At the time of organization McClintic-Marshall subscribed for 10 shares of stock for cash at par.

The attorneys proceeded with the drafting of the contracts in an effort to set forth what they understood to be the agreement of the parties. Under the earlier drafts of the contracts it was provided that the assets of McClintic-Marshall in which Bethlehem was interested should be conveyed to the Union Construction Co. for 40 of its 50 authorized shares of capital stock, which 40 shares should be issued directly to the stockholders of McClintic-Marshall, and thereafter the Union Construction Co. should transfer the assets so received to Bethlehem or "nominees" for the consideration previously stated and should in turn distribute to its stockholders the Bethlehem stocks *688 and bonds acquired in that transfer. In the case of certain *1003 of the subsidiary companies, seven in number, it was provided that the properties and assets, and not the stock, should be acquired. It was also provided that all acts of the Union Construction Co. and the seven subsidiary companies, except as otherwise provided, relating to dissolution and liquidation should be subject to approval of counsel for Bethlehem.

In addition to the preparation of the contracts covering the transaction in general between Bethlehem and McClintic-Marshall, the attorneys proceeded with the preparation of forms of conveyance to be executed in respect of the real estate located in the various sections of the United States and standing in the name of McClintic-Marshall and seven of its subsidiary companies. By December 20, 1930, the drafting of these deeds had been nearly completed.

On or about December 1, 1930, Price, Waterhouse & Co. was asked to extend its examination of the affairs of McClintic-Marshall for the purpose of making a certified balance sheet. On previous occasions its investigations had covered only the assets included in the Bethlehem transaction and it had been *689 denied access to the records covering the investment assets, or "Omitted Assets," as they were usually referred to in the conferences and papers of the parties. This further report was ordered at the instance of Bethlehem counsel for the purpose of furnishing information as to the "Omitted Assets" and the liabilities of McClintic-Marshall. The report was submitted to the directors of McClintic-Marshall under date of January 5, 1931, and in addition to the balance sheet included a statement designated "Contingent or undetermined liabilities as at June 30, 1930," and listed ten items of possible liabilities.

At some time between December 18 and December 27, 1930, the plan for effecting the transfer of the fabricating business and assets was changed. It was decided to transfer he nonfabricating assets or "Omitted Assets" to the Union Construction Co. and to transfer the fabricating business and assets direct from McClintic-Marshall to Bethlehem or "nominees." This change of plan was communicated by Smith, chief counsel for McClintic-Marshall, to Moore, chief counsel for Bethlehem, in a letter dated December 27, 1930. On December 31, 1930, Moore wrote Smith expressing approval of *690 the change in the plan of procedure, and on the same date Smith wrote Moore suggesting a conference in Moore's office on January 6, for the purpose of getting all of the papers in final form.

At or about the same time Marshall instructed Patterson, secretary of McClintic-Marshall, to call in all of the preferred stock of that corporation from employees and to pay therefor $130 per share. The stock so called covered all of the preferred stock outstanding except that held by the four common stockholders, A. W. Mellon, R. B. Mellon, *1004 C. D. Marshall, and H. H. McClintic, and excepting, of course, the 500 shares of first issue preferred then the subject matter of litigation with the Corbett estate. Some of the preferred stock so called in from employees was issued to certain of the four common stockholders at the call price of $130 per share and thereafter the stock of the McClintic-Marshall Corporation, both common and preferred, was owned by the original organizers of the Contruction Co. in the following proportions: A. W. Mellon 30 percent

R. B. Mellon 30 percent

H. H. McClintic 20 percent

C. D. Marshall 20 percent

With reference to seven of *691 the wholly owned subsidiaries of McClintic-Marshall, namely the McClintic-Marshall Construction Co., McClintic-Marshall Construction Co. of Illinois, McClintic-Marshall Construction Co. of New York, Inc., McClintic-Marshall Co. of California, McClintic-Marshall sTeel Supply Co., McClintic-Marshall Export Co., and McClintic-Marshall Co., it was understood that Bethlehem or "nominees" were to acquire the properties and assets, but not the shares of stock. Accordingly, in further preparation for the transfer of its fabricating business and assets under the agreement with Bethlehem, McClintic-Marshall, under date of December 31, 1930, addressed a letter to each of the above named subsidiaries, advising each corporation that if it would declare a liquidating dividend consisting of its assets, McClintic-Marshall "would assume and pay or perform all * * * indebtedness, liabilities, obligations and contracts, including those incurred between the date of declaration of such dividend and the actual transfer of * * * assets pursuant to said dividend."

The letters of December 31, 1930, to the above named subsidiaries suggesting the declaration of liquidating dividends were authorized at a special *692 meeting of the board of directors of the McClintic-Marshall Corporation held in the principal offices of that corporation in the Henry W. Oliver Building, Pittsburgh, Pennsylvania, at 3:30 p.m., on December 31, 1930. C. D. Marshall, H. H. McClintic, E. J. Patterson, and E. A. Gibbs, a majority of the board of directors, were present. At the same meeting resolutions were also adopted (1) authorizing the execution of proxies to vote the stock of the seven subsidiaries on resolutions declaring the liquidating dividends previously mentioned; (2) approving the purchase, in the name of the corporation, by its officers of 11,365 shares of its preferred stock at prices not in excess of $130 per share and the sale of 131 shares each to A. W. and R. B. Mellon, and one share to H. H. McClintic, and further declaring a dividend of 11,000 shares of the said preferred stock on *1005 the common stock of the corporation; (3) authorizing the execution of proxies to vote the stock of the Union Construction Co. at a meeting to be held for the purpose of increasing the capital stock of said company from 50 shares to 5,000 shares, and authorizing the board of directors to issue all or any part *693 of said stock, and (4) approving a proposal to transfer certain assets of McClintic-Marshall to the Union Construction Co. for 4,990 shares of the capital stock of said company. With reference to the transfer of assets to the Union Construction Co., the minutes read in part as follows:

The Chairman then presented to the meeting a plan of reorganization. On motion, it was unanimously resolved that said plan of reorganization should be copied into the minutes of the meeting, a copy of which plan is as follows:

PLAN OF REORGANIZATION.

McClintic-Marshall Corporation, being the owner of all of the outstanding capital stock of Union Construction Company, that is to say, ten (10) shares, will transfer to Union Construction Company certain assets in exchange for four thousand nine hundred ninety (4,990) shares of the capital stock of Union Construction Company, Union Construction Company assuming and agreeing to pay or satisfy and perform certain indebtedness, liabilities and obligations of McClintic-Marshall Corporation. The said four thousand nine hundred ninety (4,990) shares of capital stock of Union Construction Company will be immediately distributed as a dividend to the common *694 stockholders of McClintic-Marshall Corporation, the corporation's surplus being in excess of the book value of the assets conveyed to Union Construction Company.

On motion, the following resolution was unanimously adopted:

RESOLVED that the plan of reorganization read and ordered spread upon the minutes of this meeting be and the same is hereby approved and adopted.

Special meetings of the stockholders of the McClintic-Marshall Construction Co., McClintic-Marshall Steel Supply To., McClintic-Marshall Co., and McClintic-Marshall Export Co. were held in Pittsburgh during the interval from 4:30 p.m. to 5:50 p.m. on December 31, 1930. C. D. Marshall, H. H. McClintic, E. J. Patterson, and E. A. Gibbs were present, with Patterson holding the proxy of McClintic-Marshall. Resolutions were adopted declaring the liquidating dividends suggested in the letter authorized that day at the special meeting of the directors of McClintic-Marshall. In each instance the stockholders' meeting was immediately followed by a special meeting of the board of directors. The minutes indicate that in the case of the McClintic-Marshall Construction Co. of New York, Inc., the special stockholders' meeting *695 was held in Buffalo, New York, at 4:30 p.m., eastern standard time, with Welles V. Moot and S. Fay Carr as proxies for McClintic-Marshall. The special meeting of the stockholders of the McClintic-Marshall Construction Co. of Illinois was held in Chicago, according to the minutes, at 4 p.m., central standard time. The special meeting of the McClintic-Marshall Co. *1006 of California was held in San Francisco at 3 p.m., Pacific standard time, with A. G. Kazebeer, A. B. Charlton, J. G. McClure, and E. F. Gohl present, and H. H. McClintic and the McClintic-Marshall Corporation present by proxies. Special meetings of the directors of the McClintic-Marshall Construction Co. of New York, Inc., and McClintic-Marshall Construction Co. of Illinois were held in Pittsburgh at 5:50 p.m. and 6 p.m., eastern standard time, respectively, with C. D. Marshall, H. H. McClintic, E. J. Patterson, and E. A. Gibbs present.

The meetings of the various corporations were held under verbal instructions from counsel and without written notices. All preparations for the meetings had been made by counsel and Rodewald, of the firm of Smith, Buchanan, Scott & Gordon, brought to the meetings a memorandum *696 of procedure and the votes that were taken were in accordance with that memorandum. The procedure followed was that the various motions and documents were read at the first meeting of the day, some probably not in full, and thereafter it was the understanding that the same action would be taken at the other meetings. In so far as the minutes recite that the various meetings of the stockholders were called by the directors at the request of the stockholders, the minutes are incorrect. There had been no previous meetings of directors calling special meetings of the stockholders except possibly in the case of the McClintic-Marshall Co. of California, where a special directors' meeting immediately preceded the special stockholders' meeting. The minutes of the directors' meeting of the Illinois company reciting the reading of the minutes of the stockholders' meeting just held are also incorrect. No such minutes were read and no such minutes were at the meeting.

The seven subsidiary companies of McClintic-Marshall continued to operate the various properties after December 31, 1960, as they previously had done. McClintic-Marshall, which was authorized to do business in Pennsylvania, *697 took no steps to operate the properties nor to be registered to do business in any of the states in which the subsidiaries operated. Seven documents executed by McClintic-Marshall under date of February 7, 1931, recited the assumption of liabilities of each of the seven subsidiaries in consideration of the declaration of liquidating dividends previously described.

According to the minutes of the Union Construction Co., a meeting of the board of directors was held at 3:45 p.m., eastern standard time, on December 31, 1930, at the Henry W. Oliver Building in Pittsburgh, with C. D. Marshall, H. H. McClintic, and E. J. Patterson, a majority of the board of directors, present. A resolution was adopted calling for a special meeting of stockholders at 4 p.m., to be held on the same date and at the same place for the purpose of increasing the capital stock of the company from 50 shares to 5,000 *1007 shares. At 4 p.m. the special stockholders' meeting was held with the same individuals present and representing all the outstanding stock of the company, either directly or by proxy. At that meeting a resolution was adopted increasing the authorized capital stock of the corporation *698 from 50 shares to 5,000 shares. A further resolution was adopted authorizing the board of directors at their discretion to issue any or all of the stock "for such consideration and to such persons or bodies corporate (whether stockholders of this corporation or otherwise) as may be permitted by law and by the terms of certificate of incorporation as amended and as to the said directors may seem advisable." The minutes also show a second meeting of the board of directors at 4:15 p.m. on the same date and at the same place, at which a resolution was adopted in the same terms and words as that adopted earlier in the day by the board of directors of McClintic-Marshall providing for the transfer by McClintic-Marshall of certain of its assets to the Union Construction Co. for 4,990 shares of the capital stock of the latter. A resolution was also adopted approving the purchase of the Water Street property from the Kenilworth Land Co. for the sum of $130,132.55, and the giving of an option to that company for its repurchase within a period of two years. The officers were authorized to purchase from McClintic-Marshall the 10 shares of the Union Construction Co. stock subscribed for by that *699 corporation for cash at the time the Union Construction Co. was organized.

Prior to the date or dates on which the minutes of the various meetings of the seven subsidiaries and the Union Construction Co. were put in final form and entered in the minute books, drafts thereof were sent to counsel for Bethlehem for suggestions.

In accordance with the suggestion made in Smith's letter to Moore on December 31, 1930, counsel for McClintic-Marshall and Bethlehem met in New York on January 6, 1931. McMath, vice president of Bethlehem, was also present. The only substantial difficulty had to do with the clause covering the assumption of liabilities. McMath and counsel for bethlehem objected to the insertion in the contracts of a clause of general assumption by Bethlehem of the liabilities of the fabricating business of McClintic-Marshall without full disclosure on the part of McClintic-Marshall of the nature and extent of all liabilities not reflected in the McClintic-Marshall balance sheets. They were afraid that the undisclosed liabilities might include liabilities of an extraordinary nature, not to be expected in the ordinary course of the fabricating business, and on the information *700 before them, were unwilling to write the provision sought by McClintic-Marshall into the contracts. Smith insisted that the purchase of the fabricating business and the assumption of the liabilities thereof included the contingent and unknown liabilities and in keeping with *1008 instructions received by him from the common stockholders of McClintic-Marshall at a conference in Pittsburgh in the forenoon of December 31, 1930, insisted upon the blanket assumption of liabilities. As a result of this difference the work on the contracts came to a halt and C. D. Marshall and Eugene G. Grace were advised. Grace conferred with Marshall as to the fears expressed to him of hidden or abnormal liabilities and, upon being advised by Marshall that there was nothing abnormal about the contingent liabilities of McClintic-Marshall, instructed Bethlehem's counsel to proceed with the contracts along the lines desired by counsel for McClintic-Marshall.

The above conferences continued through January 8. After that date no further meetings were held until February 10, the date of delivery of the consideration and the various instruments of assignment and conveyance. During the interval between *701 January 8 and February 10, counsel for the parties were in communication with each other by mail and telephone.

After the conferences on January 6, 7 and 8, Moore caused Schlottman to be sent to Pittsburgh to make an examination, the purpose of which was to make certain that the fabricating assets to be received under the agreement with McClintic-Marshall were not depleted in any way. Moore was particularly interested in seeing that any money which had accrued by way of profits to the fabricating business from and after June 1, 1930, would be transferred with the business and not invested in some way other than in the business itself. Schlottman proceeded to Pittsburgh on or about January 12, where he spent several days making the check desired by Moore. During that time he made an audit of the list of assets which had been drawn up by Pittenger for transfer to the Union Construction Co. He also worked out with Pittenger a division of the cash between the fabricating assets which Bethlehem or its "nominees" were to receive and the nonfabricating assets which were to be transferred to Union. According to the agreement between the parties, the McClintic-Marshall stockholders *702 were to retain all dividends declared on McClintic-Marshall stock on or before October 1, 1930, and from and after that date McClintic-Marshall was to receive the dividends and interest on the Bethlehem stocks and bonds which were to be exchanged for its fabricating assets and business. The dividends on the 240,000 shares of stock were not actually paid over to McClintic-Marshall, but it was permitted to deplete the fabricating assets in an amount equal to the dividends on the 240,000 shares of Bethlehem stock from and after October 1, 1930. This was taken into consideration by Schlottman in making his check of the assets to be transferred to the Union Construction Co. and those to be transferred under the contract with Bethlehem. The fabricating *1009 assets to be transferred were also diminished to make allowance for the interest on the $8,200,000 in Bethlehem bonds, and this item was also taken into consideration by Schlottman in making his check of the assets which were to be transferred to Union. On January 14, 1931, Moore was advised by Rodewald that Schlottman and Pittenger had agreed upon the division of the assets and that the transfer to Union would be made on *703 the basis of that division. Schlottman's report of the examination was relayed to Moore by Schick, comptroller for Bethlehem, under date of January 21, 1931. Price, Waterhouse & Co. made two reports to Bethlehem under the same date covering the transactions of McClintic-Marshall and its subsidiaries from July 1, 1930, to November 30, 1930.

On January 15, 1931, an indenture between McClintic-Marshall and the Union Construction Co., bearing date of December 31, 1930, was executed. By the terms of the agreement McClintic-Marshall transferred the "Omitted Assets" to Union for 4,990 of the total 5,000 shares of Union stock and the assumption by Union of certain of McClintic-Marshall's liabilities outlined in the agreement.

It is stipulated by the parties that, except for the purpose of determining the amount of the earnings, profits, or income of McClintic-Marshall, the fair market value of all net assets of the McClintic-Marshall Corporation, including the property transferred to the Union Construction Co. and prior to giving effect to the reissuance of the 263 shares of preferred stock sold to common stockholders above described, was, at the time of the transfer to Union, $66,078,260.12. *704 It was further stipulated that the value stated is apportionable to the common and preferred stocks of the McClintic-Marshall Corporation and to the capital stock of the Union Construction Co. as follows: To preferred stock of McClintic-Marshall Corporation, 25,457 shares at $130 per share $3,309,410.00

To 60,200 shares of common stock of McClintic-Marshall Corporation 18,523,590.00

To 4,990 shares of capital stock of Union Construction Co 44,245,260.12

66,078,260.12

The ratios existing at that time, on the basis of such apportionment, between the fair market value of petitioner's 18,060 shares of common stock of the McClintic-Marshall Corporation and petitioner's 1,497 shares of common stock of the Union Construction Co. were 29.5108 per centum and 70.4892 per centum, respectively.

McClintic-Marshall and Union both kept their books on the accrual basis. Entries thereon reflecting the above transaction were dated December 31, 1930, but were actually written in the following month. Several of the checks relating to the book entries were delivered *1010 and paid on January 22, 1931. The certificate of the Union charter amendment, increasing its *705 capital stock, was signed on December 31, 1930, and filed for recordation in Delaware on January 15, 1931. On the same date the Kenilworth Land Co. conveyed the Water Street Property to Union and Union executed in favor of Kenilworth the option to repurchase. Stock transfer notices covering the transfer of stock from McClintic-Marshall to Union were dated January 16, 1931, and mailed January 17, 1931. Transfer stamp vouchers were dated January 16, 1931. Notices to debtors whose accounts were transferred by McClintic-Marshall to Union were dated December 31, 1930, and certified January 15, 1931.

Certificates for the 4,990 shares of Union stock dated December 31, 1930, were made out and delivered to the four common stockholders of McClintic-Marshall in the following month. Petitioner received 1,497 such shares. He entered the transaction in his books under date of January 1, 1931. On January 3, 1931, and shortly thereafter, dividends and interest were received on the securities later transferred by McClintic-Marshall to Union and the checks therefor were deposited to the credit of Union on the date received.

The agreement reached by Grace and Marshall on or about January 8, 1931, was *706 followed by a written contract dated January 22, 1931. In the preliminary paragraphs of the agreement were representations by McClintic-Marshall as to its properties and financial condition. Among the representations made were the following.

* * * Except for the sale, assignment and transfer of certain property, copies of the instruments covering which have been delivered to Bethlehem, and for the payment by McClintic-Marshall of certain cash dividends which are mentioned in paragraph (e) of these representations of fact and a dividend paid in the stock of another corporation owned by it, no substantial change was made in the properties and assets of McClintic-Marshall and/or the Subsidiary Companies between June 30, 1930 and the date hereof, except such changes as were made in the ordinary course of the business of McClintic-Marshall and/or the Subsidiary Companies. * * *

Other portions of the agreement describing the properties to be acquired and the consideration therefor read in part as follows:

The parties hereto desire that McClintic-Marshall shall be reorganized through the acquisition by Bethlehem of all the properties and assets owned by McClintic-Marshall (but none *707 of its capital stock) at the time the transaction covered by this Agreement (hereinafter called the Transaction) shall be closed (which shall then include the properties and assets, but not the shares of stock, of the first seven of the Subsidiary Companies as listed in said Appendix A), the immediate distribution of the bonds and shares of stock of Bethlehem which are to be delivered by it to McClintic-Marshall pursuant to the provisions of this Agreement and the dissolution as soon as practicable of McClintic-Marshall and of said first seven of the Subsidiary Companies whose properties and assets are to be acquired by Bethelehem, and to that *1011 end the parties hereto have agreed upon the plan of reorganization which is evidenced by this Agreement.

* * *

FIRST, Upon the terms and conditions hereinafter set forth McClintic-Marshall agrees that, in exchange for $,,200,000, principal amount, of the bonds of Bethlehem, hereinafter described and hereinafter sometimes called the New Bonds, and 240,000 shares of the Common Stock of Bethlehem of the same class, nature and description as the Common Stock of Bethlehem now outstanding and listed on the New York Stock Exchange, *708 McClintic-Marshall will convey, assign and transfer, or cause to be conveyed, assigned and transferred to Bethlehem, or to one or more nominees of Bethlehem as Bethlehem shall elect (a) all the properties and assets of every nature and description of McClintic-Marshall, including its good will and the right to use its corporate name, but not including any shares of its capital stock or the shares of stock of said first seven of the Subsidiary Companies, and (b) all the properties and assets of every nature and description of said first seven of the Subsidiary Companies, including their respective good wills and the right to use their respective corporate names; and Bethlehem, relying upon the representations sentations of fact of McClintic-Marshall hereinabove set forth, agrees that, in exchange for said properties and assets, Bethlehem will execute, issue and deliver to McClintic-Marshall said $8,200,000, principal amount, of the New Bonds and certificates for said 240,000 shares of said Common stock.

With certain specified exceptions Bethlehem agreed to assume all the liabilities of McClintic-Marshall. Among the obligations assumed was an item of $12,000,000 in outstanding bonds *709 of the McClintic-Marshall Construction Co., which bond issue was secured by the pledge of 160,000 shares of 6 percent cumulative preferred stock of the Aluminum Co. of America, owned by A. W. Mellon and R. B. Mellon and loaned to the McClintic-Marshall Construction Co. for such purpose. Bethlehem agreed that other collateral satisfactory to the trustee would be deposited in lieu of such Aluminum Co. stock and that the owners of such stock would be paid $50,000 per year for the use thereof during the period the Aluminum Co. stock should remain pledged. It was further provided.

* * * All deeds, assignments and other instruments of conveyance by which the properties and assets to be conveyed, assigned and transferred to Bethlehem as aforesaid shall be so conveyed, assigned and transferred shall provide that they shall take effect as of January 31, 1931, whether or not actually executed and delivered on that date.

It was also provided:

As a part of this plan of reorganization, all of the New Bonds of Bethlehem to be received by McClintic-Marshall under the provisions of this Agreement and all of said 240,000 shares of its Common Stock shall be distributed to the stockholders *710 of McClintic-Marshall.

The agreement provided that the transaction should be closed on February 3, 1931, which date was later extended to February 10, 1931.

*1012 On January 23, 1931, Grace, acting for Bethlehem, and on January 27, 1931, Marshall, acting for McClintic-Marshall, signed the above agreement bearing the date of January 22, 1931.

The agreement was placed before the board of directors of McClintic-Marshall at a special meeting held in Pittsburgh on January 26, 1931, and a resolution was adopted authorizing and directing the officers to execute the instrument for and on behalf of the corporation. Preliminary to the adoption of the resolution mentioned, the minutes show the following:

The Chairman then presented and read to the meeting a plan of reorganization. On motion, it was unanimously resolved that said plan of reorganization shall be copied into the minutes of the meeting, a copy of which plan is as follows:

PLAN OF REORGANIZATION.

Bethlehem Steel Corporation will acquire from McClintic-Marshall Corporation all the properties and assets owned by McClintic-Marshall Corporation (but none of its capital stock) at the time the transaction covered *711 by the reorganization agreement shall be closed (which shall then include the properties and assets, but not the shares of stock of McClintic-Marshall Construction Company, a Pennsylvania corporation, McClintic-Marshall Contruction Company of Illinois, an Illinois corporation, McClintic-Marshall Construction Company of New York, Inc., a New York corporation, McClintic-Marshall Company of California, a California corporation, McClintic-Marshall Steel Supply Company, a Pennsylvania corporation, McClintic-Marshall Export Company, a Delaware corporation, and McClintic-Marshall Company, a Delaware corporation, each of which companies has heretofore declared a liquidating dividend of all of its assets and properties pursuant to which McClintic-Marshall Corporation has become entitled through stock ownership or by assignment to all such assets and properties.) The bonds and shares of stock of Bethlehem Steel Corporation which are to be delivered by it to McClintic-Marshall Corporation pursuant to the provisions of the reorganization agreement will be distributed immediately to the stockholders of McClintic-Marshall Corporation, and McClintic-Marshall Corporation and the seven subsidiary companies *712 above mentioned will be dissolved as soon thereafter as practicable.

On motion, the following resolution was unanimously adopted:

RESOLVED: that the plan of reorganization which the Chairman has presented and read to this meeting and which this Board has directed to be copied into the minutes of this meeting be, and the same is hereby, approved and adopted.

Resolutions were also adopted authorizing and directing the seven subsidiary corporations to execute instruments of conveyance of their properties to Bethlehem or such other corporations as it might designate. By a further resolution a liquidating dividend was declared of all the Bethlehem stock and bonds to be received in exchange for McClintic-Marshall's fabricating business and assets. In connection with the liquidating dividend the officers were authorized and directed to require from the stockholders refunding bonds or other security which "as to said officers may seem desirable for the *1013 purpose of protecting the corporation from any and all claims or liabilities, contingent, adccrued or otherwise, which have been or may be asserted against it." The meeting was conducted from a memoradum, in the same manner *713 as the meetings of December 31, 1930.

On January 30, 1931, at a further meeting, the board passed a resolution to change the name of the McClintic-Marshall Corporation to William Penn Corporation. A resolution was also adopted directing that the stock and bonds of Bethlehem to be received for the fabricating business and assets of McClintic-Marshall be issued directly to the holders of the common capital stock of McClintic-Marshall in proportion to their respective holdings, and authorizing and directing the secretary or assistant secretary of McClintic-Marshall to deliver a certified copy of the resolution to Bethlehem. The resolution named C. D. Marshall to receive the Bethlehem stock and the bonds for the stockholders. The stockholders approved the amendment changing the name of the corporation to William Penn Corporation at a special meeting held on February 3, 1931.

Also on January 30, 1931, the name of the McClintic-Marshall Constuction Co. was changed to William Penn Construction Co. The certificate of the Secretary of State of Pennsylvania showing the change of name bears the date of February 24, 1931. On February 6, 1931, the capital stock was reduced from 50,000 *714 shares having a par value of $100 per share, to 100 shares having a par value of $100 per share. On February 7, 1931, McClintic-Marshall sold the stock of the Construction Co. to its four stockholders, A. W. Mellon, R. B. Mellon, C. D. Marshall, and H. H. McClintic, for the sum of one dollar, the 100 shares being divided 30 shares each to A. W. Mellon and R. B. Mellon and 20 shares each to C. D. Marshall and H. H. McClintic.

On January 29, 1931, the board of directors of the Bethlehem Steel Corporation, at its regular quarterly meeting held in New York City, ratified, confirmed, and approved the action taken by its president, Eugene G. Grace, in executing the above agreement with McClintic-Marshall.

The Bethlehem Steel Corporation was organized December 10, 1904, under the laws of New Jersey, and is the owner of the stock of fifty or sixty corporations, sometimes referred to as the Bethlehem group. The business of the group is that of carrying on an integrated steel business. Bethlehem itself operates no properties. Among the companies owned by Bethlehem in 1930 and 1931 were the Bethlehem Steel Co., a Pennsylvania corporation, Bethlehem Mines Corporation, a Delaware corporation, *715 Beth-Mary Steel Corporation, a Maryland corporation, Pacific Coast Steel Corporation, a Delaware corporation, and Midvale Steel Co., a Pennsylvania corporation. The largest of *1014 the operating companies in the Bethlehem group is the Bethlehem Steel Co. It operates the steel producing properties in the East, while similar properties in the West are operated by the Pacific Coast Steel Corporation. These operations include the production of structural steel, steel plate, tin plate, rolling mill equipment, and other steel products and the operation of blast furnaces. The Bethlehem Mines Corporation operates coal mines, ore mines, quarries, and properties of similar character. The Beth-Mary Steel Corporation owns the properties of the Bethlehem group which are located in the State of Maryland. It also owns the stock of the Bethlehem Iron & Steel Corporation, a New York corporation, located in New York, which owns the properties of the Bethlehem group located in New York. These properties are leased to the Bethlehem Steel Co. for operation.

The Midvale Steel Co. was incorporated under the laws of Pennsylvania on December 14, 1880. Its name was changed to McClintic-Marshall *716 Corporation on February 5, 1931. To avoid confusion it will be referred to herein as Midvale. At the time its name was changed, it had 50 shares of stock outstanding, 45 shares being held directly by Bethlehem and the other five shares by directors.

During the months of September, October, and November, 214,159 shares of Bethlehem common stock were purchased on the New York Stock Exchange, under authorization from Grace, for use in the acquisition of the fabricating business and assets of McClintic-Marshall. In authorizing the purchase of stock for the purpose mentioned above, Grace had the informal approval of the members of Bethlehem's board of directors.

The cash of the Bethlehem group is carried by the Bethlehem Steel Co. in an account designated as "Inter-company Balances." Through this account each company is credited with its portion of the profits on any contract or job in which it participates and with the cash coming into the account through such company. In a similar manner each company is charged through the account with its expenditures. In making the purchases of the Bethlehem stock described above, the checks were drawn by the Bethlehem Steel Corporation. *717 The books of that corporation do not show acquisition of the stock, however, and it was not charged with the cash so expended, its cash being neither increased nor decreased as a result of the purchases. The disbursements for the shares purchased were charged against the Bethlehem Mines Corporation and described as disbursements "for account of Bethlehem Mines Corporation." The shares, when acquired, were carried on the books of the Bethlehem Mines Corporation in an account designated "Contingent Fund Assets." In its balance sheet of December 31, 1930, the Bethlehem Mines Corporation carried the 240,000 shares of Bethlehem stock as *1015 "Investment-Capital Stock of Domestic Corporations." The balance sheet of Bethlehem for the same date showed these shares as outstanding. The consolidated balance sheet showed a footnote to the effect that the 240,000 shares were to be used in part payment for McClintic-Marshall assets.

Upon the purchase of the various lots of Bethlehem stock, the shares so acquired were transferred to the names of individuals. These individuals signed statements to the effect that the stock so held was owned by Bethlehem, and they assigned to it any *718 and all dividends thereon. The dividends paid during the year 1930 and until February 1931 on the stock in question were not paid to the individuals in whose names the shares stood, nor were they paid to Bethlehem, in accordance with the signed orders of those individuals; the dividends were paid to the Bethlehem Mines Corporation which, according to the books of account, was the purchaser and owner of the stock. Bethlehem at no time received credit or showed receipt of the dividends on its books. The entries on the books were made with the intention of showing the Bethlehem Mines Corporation as the owner of the stock.

Some time in February 1931, 25,841 shares of Bethlehem stock acquired by the Bethlehem Mines Corporation prior to the McClintic-Marshall negotiations were written down on the books to the average cost of the 214,159 shares acquired during the months of September, October, and November, 1930. The total write-down amounted to $912,849. Thereafter the average cost of the entire 240,000 shares was reflected as $76.74 per share. Bethlehem was never at any time charged with the amount by which the stock was written down. The Bethlehem Mines Corporation was credited *719 with the amount of the write-down and an account of the Bethlehem Steel Co., designated as "Reserve for Depreciation of Investments", was charged.

By instruments dated February 7, 1931, McClintic-Marshall, McClintic-Marshall Construction Co., McClintic-Marshall Construction Co. of Illinois, and McClintic-Marshall Steel Supply Co. conveyed to Midvale all their real estate and interest in real estate. By instruments bearing the same date the McClintic-Marshall Construction Co. of New York, Inc., conveyed its real estate to the Bethlehem Iron & Steel Corporation, and the McClintic-Marshall Co. of California conveyed its real estate to the Pacific Coast Steel Corporation. By bills of sale also bearing the date of February 7, 1931, McClintic-Marshall, McClintic-Marshall Construction Co., McClintic-Marshall Construction Co. of Illinois, McClintic-Marshall Construction Co. of New York, Inc., McClintic-Marshall Co. of California, McClintic-Marshall Steel Supply Co., McClintic-Marshall Export Co. And McClintic-Marshall *1016 Co. transferred all assets except real estate and patents to Midvale. The transfers of patents and trade marks were covered by separate instruments to meet *720 the requirements of the offices in which notices of such transfers were to be filed.

Under date of February 10, 1931, an instrument designating Bethlehem as party of the first part, McClintic-Marshall as party of the second part, and the seven subsidiary corporations as parties of the third part, and reciting the transfer and conveyance by McClintic-Marshall to Bethlehem or "nominees", was executed by Bethlehem, wherein Bethlehem, in accordance with the terms of the agreement of January 22, 1931, assumed and agreed to pay or to cause to be paid all liabilities of the group, except those specifically excepted in the January agreement. By an instrument bearing the same date and naming Bethlehem, the McClintic-Marshall Construction Co. and the Union Trust Co. of Pittsburgh as parties, Bethlehem assumed the $12,000,000 bond issue of the Construction Co. A third instrument, also dated February 10, 1931, was executed by Bethlehem, the McClintic-Marshall Construction Co., A. W. Mellon, and R. B. Mellon. It provided for the substitution of collateral in connection with the $12,000,000 bond issue in place of the then existing collateral which belonged to petitioner and R. B. Mellon.

*721 In accordance with the request of McClintic-Marshall, the 240,000 shares of Bethlehem common stock were issued 72,000 shares each to A. W. Mellon and R. B. Mellon and 48,000 shares each to C. D. Marshall and H. H. McClintic. On February 10, 1931, C. D. Marshall delivered his receipt covering the 240,000 shares of Bethlehem common stock and the $8,200,000, principal amount, of Bethlehem 4 1/2 per cent Serial Gold Bonds, reading as follows:

RECEIVED from Bethlehem Steel Corporation, a New Jersey corporation, $8,200,000, principal amount, of its Four and One-Half Per Cent. Serial Gold Bonds and Certificates for 240,000 shares of its common stock made out in the following names and for the number of shares set after each such name, respectively: Andrew W. Mellon 72,000 shares

Richard B. Mellon 72,000 shares

Howard H. McClintic 48,000 shares

Charles D. Marshall 48,000 shares

Dated February 10, 1931.

[Signed] C. D. MARSHALL.

The bonds after authentication by the Union Trust Co. of Pittsburgh, as trustee, were actually delivered by William J. Brown, treasurer of Bethlehem, to the Bankers Trust Co. in New York, and the Bankers Trust Co.'s receipt was delivered *722 to Marshall.

The four common stockholders of McClintic-Marshall directed a letter to Bethlehem, bearing the date of February 10, 1931, granting *1017 an option to purchase the 100 shares of William Penn Construction Co. stock for the sum of one dollar at any time within ninety days after the collateral furnished by A. W. Mellon and R. B. Mellon in connection with the $12,000,000 bond issue of the Construction Co. should be released from the lien of the trust. Bethlehem exercised the option and acquired the stock for the sum of one dollar. The Construction Co. is still in existence, but holds no properties and conducts no business.

The stock of the Riter-Conley Co., Kenilworth Land Co., Steel Frame House Co., and Steel Frame House Finance Co. was transferred to Midvale. It was delivered on February 10, 1931. On each instance the certificates were delivered endorsed in blank and the name of Midvale (McClintic-Marshall Corporation of Pennsylvania) was written in.

All of the properties transferred and conveyed by McClintic-Marshall and its subsidiaries in accordance with the agreement of January 22, 1931, including the real estate in California and New York and the *723 stock of the Kenilworth Land Co., Riter-Conley Co., Steel Frame House Co., and Steel Frame House Finance Co., were entered on the books of Midvale. None of the properties acquired and none of the liabilities assumed in connection therewith were ever entered on the books of Bethlehem. In May of 1931 the California real estate was transferred by proper book entries to the Pacific Coast Steel Corporation and the New York real estate was similarly transferred to Bethlehem Iron & Steel Corporation. In making these transfers the Pacific Coast Steel Corporation was charged with the net amount of $660,939 for the real estate conveyed to it and Midvale was credited with that amount, and Bethlehem Iron & Steel Corporation was charged with the net amount of $2,397,275 for the real estate it received and Midvale was credited in the same amount. The minute books of those corporations contain no reference to the acquisition of any of the McClintic-Marshall assets.

After the name of Midvale was changed to McClintic-Marshall Corporation on February 6, 1931, a new ledger was set up on which an account was opened designated as "Investment in properties purchased from McClintic-Marshall, (Del. *724 )." The amount of the investment was shown as $26,617,246. The journal voucher from which the entry was posted was dated March 12, 1931, and designated as being for the "Month of February, 1931." The voucher reads as follows:

To record the purchase of the properties of McClintic-Marshall Corporation, (Del.) pursuant to the agreement dated January 22, 1931, between Bethlehem Steel Corporation and McClintic-Marshall Corporation, (Del.). Delivery made to McClintic-Marshall Corporation, (Del.) of 240,000 shares of Bethlehem Steel *1018 Corporation Common Stock - without par value and $8,200,000 par amount, of Bethlehem Steel Corporation 4 1/2% Serial Gold Bonds, in payment of properties. Account Description Amount Amount

2-F Marketable Securities 240,000 shares - B.S. Corp. Common Stock $18,417,246.00

9-A Inter-Company Balances Bethlehem Steel Corporation 8,200,000.00

$26,617,246.00

A second journal voucher of Midvale dated March 13, 1931, also purporting to cover a transaction in February, shows "Purchase from Bethlehem Steel Corporation of 240,000 shares of Bethlehem Steel Corporation Common Stock, without par value" at $76.74 per share, *725 or $18,417,246. Under the same date, however, a Bethlehem Mines Corporation journal voucher was drawn to show transfer of 240,000 shares of Bethlehem common stock direct from the Bethlehem Mines Corporation to Midvale for $18,417,246. The name of Midvale (McClintic-Marshall Corporation) was subsequently stricken through and the name of Bethlehem inserted therefor. Thereafter, under date of April 15, 1931, journal vouchers were entered in the records of Bethlehem to show a purchase in February of the 240,000 shares of Bethlehem common stock by Bethlehem from the Bethlehem Mines Corporation, at $76.74 per share, or $18,417,246, and at the same time a sale of the same shares, at the same price, to Midvale.

The 240,000 shares of Bethlehem common stock were carried on the books of the Bethlehem Mines Corporation as its property from the time of purchase on the New York Stock Exchange up to the time of transfer to Midvale, and at no place on the books of Bethlehem is there any entry showing that Bethlehem transferred the said 240,000 shares of stock to McClintic-Marshall for its fabricating business and assets.

The dividends on the 240,000 shares of Bethlehem common stock up to *726 February 1931 were eventually credited to Midvale. By the terms of the agreement McClintic-Marshall was entitled to the dividends on the said stock after October 1, 1930, and this credit was made to Midvale to offset the amount by which the fabricating business and assets were diminished when transferred in accordance with the agreement dated January 22, 1931.

On February 10, 1931, the fair market value of the 240,000 shares of Bethlehem common stock was $13,920,000 and that of the $8,200,000, face value, of its bonds was $7,913,000, or 63.7567 per centum and 36.2433 per centum, respectively, of the total of $21,833,000.

It was stipulated that the accumulated earnings or profits of McClintic-Marshall available for distribution in dividends were $25,000,000 as of February 10, 1931, of which sum not less than $18,000,000 was accumulated prior to December 31, 1930. The amounts were so *1019 stipulated without prejudice to the contentions of the parties as to their availability for distribution as dividends by McClintic-Marshall, Union, and Pitt Securities Corporation, a corporation subsequently organized to take over part of the assets transferred by McClintic-Marshall *727 to Union.

Under date of February 15, 1931, Bethlehem directed a letter to Midvale (McClintic-Marshall Corporation of Pennsylvania) stating that the letter was to confirm an agreement wherein Midvale had agreed to assume and had assumed all obligations of Bethlehem under its agreement with McClintic-Marshall dated February 10, 1931, except the $12,000,000 bond issue of the McClintic-Marshall Construction Co., and had agreed to pay to Bethlehem $20,200,000 on demand and a further amount equal to the cost of the 240,000 shares of Bethlehem common stock. On the same date Bethlehem directed a letter to Beth-Mary Steel Corporation, stating that it was to confirm the assumption by Beth-Mary Steel Corporation of the $8,200,000 in Bethlehem bonds used in the acquisition of the fabricating business and assets of McClintic-Marshall and the assumption of the $12,000,000 bond issue of the McClintic-Marshall Construction Co., and further stating that in connection with such assumption Bethlehem had assigned and transferred all of its rights to receive from Midvale the $20,200,000, as above set forth.

The transfer of properties between members of the Bethlehem group was not unusual when suggested *728 for purposes of business expediency, but in each instance where such transfers were made the proper charges and credits were entered on the books of each corporation and record ownership actually passed in respect of assets so transferred. After such transfers the recipient of the assets treated those assets as its own, taking up the income therefrom and sustaining the expenses incident thereto.

In connection with the acquisition of the property of McClintic-Marshall by the various subsidiaries of the Bethlehem Steel Corporation and the assumption of the bond indebtedness of the Beth-Mary Steel Corporation, no change was made in the outstanding capital stock of any of the corporations. Bethlehem's outstanding common stock amounted to 3,200,000 shares. It also had 7 percent cumulative preferred stock having a par value of $100,000,000 outstanding.

On January 20, 1931, the Union Trust Co. and Marshall and McClintic, representing themselves and A. W. Mellon and R. B. Mellon, entered into an agreement providing that the Trust Co. would purchase from them Bethlehem bonds in the principal amount of $8,200,000, to be issued by that company under the terms set forth in the contract. *729 On February 10, 1931, the Bankers Trust Co. informed Marshall that it held the bonds subject to his order. On *1020 February 11, 1931, Marshall authorized the Bankers Trust Co. to deliver them to the Union Trust Co. in accordance with the agreement of January 20. The Union Trust Co. issued its checks to the petitioner and the other McClintic-Marshall stockholders. The petitioner received $2,373,900, representing the sale of his portion of the bonds at 96, plus accrued interest of $12,300. The petitioner entered the amount so received on his books under date of February 11, 1931, and reported in his income tax return a profit of $1,922,631. It was admitted in the pleadings that the item of $12,300 was erroneously reported by the petitioner as interest received.

Bethlehem had no arrangement or agreement with the Trust Co. governing the disposition of the bonds after issuance.

McClintic-Marshall, the name of which was changed to William Penn Corporation, has conducted no business since February 10, 1931, and since that date has had no assets. In February 1933 Its certificate of incorporation was amended, reducing its capital stock to 100 shares having a par value of *730 $100 per share.

IV. - The Liquidation of Union Construction Co.

The Koppers Co. - Union Construction Co. reorganization. - Among the investment assets transferred to Union by McClintic-Marshall was a block of 500,000 of the 600,000 outstanding common shares of the Koppers Co., a Delaware corporation (hereinafter called Koppers Co.), engaged, with its many subsidiaries, in building byproduct coke ovens, in processing coal, in manufacturing and marketing the byproducts thereof, and in carrying on related industries. The remaining 100,000 shares of Koppers Co. stock were owned by Henry B. Rust, chairman of the board of directors of the Koppers Co., and by members of his family.

For about a year prior to March 1931 the officers of the Koppers Co. had been considering a plan to reorganize the company for the purpose of consolidating the interests which the company's stockholders owned, in the same proportions, in other companies. A. W. Mellon, R. B. Mellon, C. D. Marshall, H. H. McClintic, and H. B. Rust owned the common shares of Fuel Investment Associates, which in turn owned a group of other companies, principally located in Boston. The reorganization was proposed *731 also in order to secure individual instead of corporate ownership of the stock of these various companies and to facilitate the economical control and operation of such corporations. Therefore, the following plan, dated March 30, 1931, was formulated and submitted to the interested stockholders:

REORGANIZATION OF THE KOPPERS COMPANY.

The stock of the Koppers Company, formerly held by McClintic-Marshall Corporation, has recently been transferred to The Union Construction Company. It is desired to have this stock distributed to the stockholders of The Union Construction *1021 Company without recognition of gain for tax purposes. In this connection it has been suggested that it might be advisable to combine under one Massachusetts Trust all of the assets now owned by The Koppers Company as well as Fuel Investment Associates, an existing Massachusetts Voluntary Association, which owns a majority of the common stock of Eastern Gas and Fuel Associates. (The present capitalization of Fuel Investment Associates consists of 600,000 common shares owned by the gentlemen who at present, directly or indirectly, own The Koppers Company and 315,630 $7.00 preferred shares owned by *732 Koppers Gas and Coke Company. It has substantially no outstanding liabilities.)

The following plan has been suggested to carry out the foregoing purposes and incidentally also to strengthen the Fuel Investment preferred stock and thereby the earnings of Koppers Gas Coke Company.

THE PLAN.

(1) The stockholders of The Koppers Company, except the Union Construction Company, unite in organizing The Koppers Company, a Massachusetts Trust, hereinafter called Company X to which they transfer all of their shares of stock of the present Koppers Company of Delaware in exchange for all of the stock of Company X issued to them in proportion to their respective contributions to Company X.

(2) The Union Construction Company transfers to Company X all of its stock in the existing Koppers Company of Delaware in exchange for shares of stock of Company X issued to it also in a proportion based on its contribution to Company X.

(3) The Union Construction Company distributes to its shareholders pro rata the stock of Company X acquired under step (2).

(4) The common shareholders of Fuel Investment Associates being the same as the common shareholders of Company X transfer all shares of *733 Fuel Investment Associates to Company X as contribution to capital surplus - or sell the same to Company X for the figure they originally paid for such shares which was a nominal sum.

(5) The Koppers Company may now be dissolved.

* * *

The first four steps thus outlined were carried out.

On April 24, 1931, a Massachusetts voluntary association named the "Fuel Company" was formed. On May 8, 1931, its name was changed to "The Koppers Company" (hereinafter called the Koppers trust). Its authorized capital was 500,000 shares of no-par value. Fifty of its shares were issued to H. B. Rust in exchange for 10 shares of Koppers Co. stock. On April 25, 1931, the declaration of trust was amended to assign a par value of $1 to each share and the remaining 499,950 shares of the trust were issued to H. B. Rust and members of his family in exchange for 99,990 shares of the Koppers Co. stock.

On May 8, 1931, the Koppers trust increased its authorized shares from 500,000 to 3,000,000. On the next day its trustees accepted a plan of reorganization proposed by Union, whereby Union transferred the 500,000 outstanding shares of Koppers Co. stock in exchange for the remaining 2,500,000 *734 shares of the Koppers trust. *1022 Upon the instruction of Union, such shares were issued to A. W. Mellon, R. B. Mellon, C. D. Marshall, and H. H. McClintic in the amounts of 750,000, 750,000, 500,000, and 500,000 shares, respectively. That method was adopted pursuant to a resolution of the Union board of directors, passed on May 9, 1931, which provided that a dividend of the 2,500,000 shares of Koppers trust be declared payable to the Union common stockholders and charged against its surplus. At the same time the officers of the trust were authorized to purchase all of the outstanding shares of Fuel Investment Associates. That purchase was made in May 1931.

The petitioner's books show the receipt of his Koppers trust shares on May 9, 1931, as a tax-free dividend resulting from the reorganization of Union. Appropriate entries appear on Union's books reflecting the transfer of the Koppers Co. stock to the Koppers trust, the distribution of Koppers trust shares to Union stockholders, and the reimbursement of the Koppers Co. for transfer stamps.

It was stipulated that, except for the purpose of determining the amount of the earnings, profits, or income of Union, at the *735 time of the transfer the fair market value of all the net assets of Union, including the 500,000 shares of Koppers Co. common stock, was $44,993,766.73, of which $37,500,000 was apportionable to the 2,500,000 shares of Koppers trust and $7,493,766.73 was apportionable to the 5,000 shares of capital stock of Union, and that the ratios existing at that time, on the basis of such apportionment, between the fair market value of the petitioner's 1,500 shares of capital stock of Union and the petitioner's 750,000 shares in the Koppers trust, were 16.6551 percent and 83.3449 percent, respectively.

The Pitt Securities Corporation - Union Construction Co. reorganization. - On May 21, 1931, the Pitt Securities Corporation (hereinafter called Pitt) was organized under the laws of the State of Delaware with an authorized capital of 50 shares of stock of $100 par value each. On May 22, 1931, the officers of Union subscribed for 10 shares of Pitt stock and paid therefor $1,000 in cash. The subscription contained an option to repurchase the shares at $105 per share. On the same day Pitt accepted the subscription. On May 25, 1931, the board of directors of Union approved such subscription *736 and directed its officers to transfer the 10 shares of Pitt stock to Pitt when the latter should exercise its option to repurchase. Thereupon the board adopted the following plan of reorganization:

Union Construction Company, being the owner of all of the outstanding capital stock of Pitt Securities Corporation, that is to say, ten (10) shares, will transfer to Pitt Securities Corporation certain assets in exchange for the remaining forty (40) shares of the capital stock of Pitt's Securities Corporation which it is authorized by its charter to issue, Pitt Securities Corporation assuming and agreeing to pay or satisfy and perform certain indebtedness, liabilities and obligations *1023 of or assumed by Union Construction Company. The said forty (40) shares of capital stock of Pitt Securities Corporation will be immediately distributed as a dividend to the stockholders of Union Construction Company, the corporation's surplus being in excess of the book value of the assets conveyed to Pitt Securities Corporation.

and authorized its officers to execute an indenture in harmony with the plan. On the same day the officers of Pitt adopted resolutions directing reciprocal actions *737 by Pitt.

By the identure dated and executed on June 1, 1931, Union transferred to Pitt, in exchange for 40 shares of stock of the latter company, assets valued at $12,552,471.78 and consisting of $980,279.51 in cash, certain accounts receivable, stocks, bonds, miscellaneous property, and the Water Street land. Pitt agreed to assume all of Union's liabilities and obligations except those relating to the redemption of the first preferred stock of McClintic-Marshall (being those involved in the Corbett suit). Union thereupon distributed to its stockholders the 40 shares of Pitt stock, of which the petitioner received 12 shares.

On June 1, 1931, Pitt reacquired the 10 shares of its own stock from Union and paid $1,050 therefor. The transfer of the assets from Union to Pitt is reflected by appropriate entries on the books of both companies under date of June 1, 1931, as to all assets but cash and, under date of June 11, 1931, as to cash.

On June 2, 1931, Pitt received a payment on an account receivable transferred from Union and the usual rent from the lessee of the Water Street property. Later in the month it received further payments on accounts receivable so transferred. *738 On June 1, 1931, and thereafter in that month, Pitt paid certain current bills such as were formerely paid by Union. Subsequent to June 1, 1931, Union received no cash except the $1,050 representing the repurchase of the Pitt stock.

The certificates of stock of Pitt issued to the Union stockholders were dated June 1, 1931, but the receipts therefor were undated. The receipt of the Pitt stock by the petitioner is shown on his books under date of June 1, 1931. The original issue stamps affixed to the stock certificates were marked "cancelled" June 1, 1931, but the voucher and check therefor were dated December 29, 1931, and June 8, 1932, respectively. The vouchers for the purchase of the transfer stamps upon the transfers of stock by, Union to Pitt were prepared May 25, 1931. The checks therefor were dated May 29, 1931, and paid on various dates from June 8 to July 2, 1931.

On June 5, 1931, all the stockholders of Union consented in writing to the dissolution of that corporation and the distribution of its assets in complete liquidation thereof after the payment or other disposition of its debts and obligations. The board of directors of *1024 Union thereupon ordered *739 such dissolution and distribution and authorized its officers to take all action necessary to accomplish that purpose. On or after June 5, 1931, and during that year, Union distributed its remaining assets to its stockholders. The corporation was dissolved on June 29, 1931. At the time of the said distribution the fair market value of the gross assets distributed was $3,112,746.83, of which the petitioner received securities of the fair market value of $922,145.16, accrued interest on bonds amounting to $11,323, and $380.01 in cash. The petitioner's books show the receipt of such distribution under date of July 27, 1931.

On June 5, 1931, the Union directors also authorized the distribution to its individual stockholders in proportion to their stock ownership of $5,000 shares of Koppers Gas & Coke Co. stock, 300 shares of Bellefield Co. stock, and 1,500 shares of Westinghouse Air Brake Co. stock. Vouchers were prepared on May 25, 1931, and checks were issued on May 29, 1931, to cover state and Federal transfer stamps upon the various shares of stock in the said three companies.

It was stipulated that except for the purpose of determining the amount of the earnings, profits *740 or income of Union, at the time of the transfer from Union to Pitt and the distribution of the Pitt stock the fair market value of all the net assets of Union was $7,450,575.28, apportionable as follows: To 40 shares of capital stock of Pitt Securities Corporation $4,520,158.61

To $5,000 shares of capital stock of Union Construction Co. 2,930,426.67

7,450,575.28

and that the ratios then existing, on the basis of such apportionment, between the fair market value of the petitioner's 1,500 shares of capital stock of Union and petitioner's 12 shares of capital stock of Pitt were 39.3316 and 60.6684 percent, respectively.

During the period from its formation to its dissolution Union had net earnings (before distribution, if any) amounting to the sum of $1,060,135.23.

The Union-Koppers reorganization and the Union-Pitt reorganization were parts of a plan for the liquidation of Union.

In his return, petitioner reported as capital gain the net excess of the cash plus the market value of the securities distributed to him pursuant to the liquidation resolution of June 5, 1931, over the adjusted basis for his Union stock, after allocation of part of his original *741 basis for such stock to Koppers shares and Pitt stock. In computing his capital gain, petitioner deducted the sum of $139,577.03, being the amount of the liabilities of Union which had assumed as consideration for the liquidation distribution and which had been paid by Pitt at his request and for his account. In computing the gain with respect to the Union liquidating dividend (as in the case of the *1025 Bethlehem bonds) petitioner used as the March 1, 1913, value of McClintic-Marshall Construction co. stock a figure of $353 per share for the common and $148 per share for the preferred, stating on his return that such figures were tentative and that subsequently proper figures would be presented. In the notice of deficiency respondent made no change in this determination of gain on the liquidation of Union except to assert a lower adjusted basis for petitioner's Union stock on account of his determination of March 1, 1913, value of McClintic-Marshall Construction Co. stock.

In his answer respondent affirmatively avers that he erred in his notice of deficiency (1) in understating the amount of the distribution in liquidation; (2) in applying section 112(g) to a portion *742 of the distributions; and (3) in failing to treat the entire amount of the gain realized on such liquidation as ordinary income subject to surtax rates.

V. - The Payments by Union Construction Co. and Pitt Securities Corporation for the Account of Petitioner.

At the request of the petitioner and the three other common stockholders, transferees of the assets of McClintic-Marshall, Union paid during 1931 the following amounts for the purposes indicated: Purpose Date Amount

Legal expenses in re McClintic-Marshall - Bethlehem reorganization Feb. 13 $75,000.00

Accountant's fees rendered McClintic-Marshall Feb. 17 3,291.50

Annual fee for statutory representation of McClintic-Marshall Feb. 17 100.00

Reimbursement to Bethlehem for stock transfer stamps Feb. 21 10,032.00

Apr. 4 233.50

Counsel fees for services and expenses in re Bethlehem transaction Apr. 4 2,518.28

May 25 3,801.26

Reimbursement to Bethlehem for 1930 income tax May 25 2,369.87

97,346.41

The above payments were made for the account of the petitioner and the three other stockholders in proportion to their stock ownership in McClintic-Marshall and carried on Union's *743 books as open accounts against each of them. Union transferred those accounts to Pitt and appropriate entries reflecting such transfers were made on Pitt's books. The item of $2,369.87, paid May 8, 1931, was an indebtedness of Union which was erroneously charged to the petitioner and other stockholders and paid by them in December 1934, as hereinafter set forth. Petitioner's proportion of such item was $710.97. During 1931 Pitt paid other obligations of McClintic-Marshall aggregating $2,327.89, for which petitioner and its other stockholders were liable as such transferees and charged them to the stockholders as accounts receivable. Thus, Pitt's books showed a total charge of *1026 $29,902.30 to the petitioner. The petitioner's books show the same amount under date of December 31, 1931, as his debt to Pitt.

On June 5, 1931, the petitioner and the three other common stockholders of Union, in consideration of the assignment and transfer to them by Union of all of its assets in complete liquidation, entered into an agreement with Union to pay, in proportion to their stockholdings, all of Union's liabilities and obligations relating to the Corbett claim, which was primarily *744 a potential liability of McClintic-Marshall and had been assumed by Union. The Corbett case was settled on or about July 16, 1931, at an aggregate cost of $465,256.77. This sum was composed of the following items which Pitt paid at the request and for the accounts of the petitioner and the three other Union stockholders: Date Payee Purpose Amount

July 16 George Wharton Pepper Settlement of claim $400,000.00

July 24 Ward & Gray Legal expenses 11,730.37

Pepper, Bodine, Stokes & Schoch do 30,169.49

Smith, Buchanan, Scott & Gordon do 23,333.33

July 27 Ward & Gray Costs 23.58

Total 465,256.77

The foregoing payments were charged by Pitt to the accounts of the petitioner and the three other Union stockholders and carried on Pitt's books as accounts receivable. On July 27, 1931, the petitioner's accounts reflected the payment of $139,577.03 made by Pitt for him, but the sum of $29,203.93 originally paid by Union and assumed by Pitt did not appear on his books until December 1, 1931. The charge of $169,479.33 against the petitioner on the books of Pitt remained unchanged until December 7, 1934, when the amount was balanced by a credit *745 entry of the same amount. No interest was charged or paid on the account.

Under date of July 27, 1931, an entry appears on the petitioner's journal in the amount of $139,577.04 described as "Bills payable - Pitt Secur. Corp. Mr. Mellon's liability as transferee of McClintic-Marshall Corp. on account of the Corbett suit - See agreement of June 5, 1931." In the case of R. B. Mellon, the item was not entered on his books as bills payable to Pitt until December 31, 1931. The offsetting debit entry was to R. B. Mellon's Union account, a capital account covering his investment in that corporation. The pages preceding the entry of July 27, 1931, contain entries dated in December of that year.

Thereafter, the record reveals no intention on the part of the petitioner to repay such sums until on or about November 30, 1934. On that date the estate of R. B. Mellon sent a letter to Pitt stating that according to the books of the late R. B. Mellon, he was indebted to Pitt in the sum of $169,479.34 and inclosing a check for that amount. *1027 Thereupon Pitt made immediate demand for payment of a similar amount from the petitioner and proportionate amounts from the other two stockholders. *746 On December 4, 1934, the petitioner paid to Pitt $169,479.33 and recorded such payment on his bills payable account. In December 1934 McClintic and Marshall also made payment to Pitt of their portions of such sums so appearing on Pitt's books.

During February, March, and May, 1931, Union made several payments for McClintic and Marshall. After June 1, 1931, Pitt made similar payments for them. These items were carried in separate accounts on Union's books (and subsequent to June 1, 1931, on Pitt's books) and were currently repaid by the debtors.

On March 7, June 13, September 14, and December 15, all in 1932, cash distributions described as dividends were made by Pitt to its four stockholders in proportion to their respective stockholdings. The amount distributed on each occasion was $275,000. In each instance petitioner received $82,500 and R. B. Mellon, Marshall, and McClintic each received proportionate amounts. Thus petitioner received in 1932 dividends aggregating $330,000. At the time the payments described above were made, no steps were taken to apply any portion of he amounts distributed against the accounts carried on the books of Pitt as owing to that corporation *747 by each of the four stockholders. Pitt acquired the cash so distributed by reason of the payment by the Koppers trust of its account of $1,106,250. No action authorizing the distribution of a dividend to the stockholders was taken by the board of directors until March 2, 1933. On that date a meeting of the board of directors was held, the minutes of which recite the payment by the Koppers trust of its account and the distribution of the proceeds, with the exception of $6,250, to the stockholders of Pitt in accordance with their shareholdings and further recite the adoption of a resolution approving the action of the officers of the company in making such distribution.

At the time of the distribution of the Bethlehem stock and bonds to the four stockholders of McClintic-Marshall, February 10, 1931, they executed a refunding receipt which provided that if any of the stock or bonds so received by them should be required to pay the Corbett claim or any liability arising from it, they would return to McClintic-Marshall such Bethlehem securities as might be needed for that purpose. They also deposited 12,500 shares of Bethlehem common stock as collateral security to protect the refunding *748 receipt agreement. Upon the settlement of the Corbett suit the Bethlehem stock and refunding receipt were returned to the four stockholders.

During the period from its formation to the payments made in July 1931, aggregating $465,256.77 and relating to the Corbett claim, Pitt did not sustain an operating loss.

*1028 In his notice of deficiency respondent made no addition to petitioner's income on account of the payments, aggregating $169,479.33, made on his behalf by Union and Pitt. In his answer he affirmatively alleged that such payments constituted dividends as contemplated by section 115 of the Revenue Act of 1928.

The payments above described, aggregating, in the case of petitioner, $169,479.33, were dividends and not loans to petitioner.

VI. - The Fair Market Value of Stock of McClintic-Marshall Construction Co.

In his return for the taxable year, in computing gain with respect to a liquidating dividend from the Union Construction Co. and on the sale of certain bonds of the Bethlehem Steel Corporation acquired by him, as herein elsewhere described, petitioner used as the value on March 1, 1913, of 9,030 shares of common stock and 600 shares of the preferred *749 stock of the McClintic-Marshall Construction Co., then owned by him, a figure $353of per share for the common and $148 per share for the preferred. In the return the following reservation was made:

In the computation of gain with respect to the liquidating dividend received from Union Construction Company and the sale of bonds of Bethlehem Steel Company (reported on Schedule D), a tentative basis has been adopted. It is believed that the gain so computed and returned is in excess of the gain actually realized. In due course a proper basis will be presented and claims for refund filed.

The respondent determined the March 1, 1913, value of the common and the preferred stock to be, respectively, $158.54 and $123.23 per share. At the hearing the March 1, 1913, value of the preferred stock was stipulated to be $130 per share.

The McClintic-Marshall Construction Co. (hereinafter in this part sometimes called the Company) was organized under the laws of Pennsylvania on March 20, 1900, by A. W. Mellon, R. B. Mellon, H. H. McClintic, and C. D. Marshall. On or about April 1, 1900, it acquired the assets and assumed the liabilities of a bridge company at Pottstown, Pennsylvania, *750 paying therefor $137,500 par value of 7 percent cumulative nonparticipating preferred stock. At the same time it issued for cash at par $87,500 par value of its 7 percent cumulative nonparticipating preferred stock and $100,000 par value of common stock. During 1901 and 1902 additional common stock of $150,000 par value was issued for cash at par and $225,000 par value of additional 7 percent cumulative nonparticipating preferred stock was issued for cash at par.

On or prior to December 31, 1908, all of the 7 percent cumulative nonparticipating preferred stock was redeemed by the Company for *1029 cash at par. On or about December 31, 1908, the Company issued as stock dividends to its common stockholders $2,760,000 par value of common stock and $290,000 par value of a new 6 percent noncumulative participating preferred stock. Thereafter, prior to March 1, 1913, the Company issued for cash at par additional shares of said 6 percent noncumulative participating preferred stock of the par value of $196,900. During the fiscal year ended January 31, 1913, and the month of February 1913 the Company redeemed, partly at par and partly at book value, shares of said 6 percent noncumulative *751 participating preferred stock having a total par value of $107,800.

In August 1912 the Company issued 500 shares of its common stock having a par value of $50,000 as additional compensation to W. M. Sterrett for services he was about to render the Company by going to the Panama Canal Zone in connection with a contract for the construction and erection of the Panama Canal lock gates. This stock was charged to the Panama Canal account on the books of the company at the amount of $50,000 and in the claim subsequently filed with Congress on account of the loss on the Canal contract the sum of $50,000 was included as part of the total cost.

On March 1, 1913, there were outstanding 30,600 shares of common stock of the par value of $100 each and 3,791 shares of 6 percent noncumulative participating preferred stock of the par value of $100 each. The preferred stock was subject to call in whole or in part at the option of the board of directors at $100 per share, or at the book value as shown by the last annual statement of assets and liabilities of the Company submitted to and approved by the board of directors, whichever was greater.

The capital paid in and retained in the business *752 exclusive of stock dividends at the end of each fiscal year was as follows: Fiscal year Common Preferred Total

1901 $100,000 $225,000 $325,000

1902 200,000 450,000 650,000

1903 250,000 450,000 700,000

1904 250,000 395,000 645,000

1905 250,000 350,000 600,000

1906 250,000 350,000 600,000

1907 250,000 350,000 600,000

1908 $250,000 $350,000 $600,000

1909 250,000 124,100 374,100

1910 250,000 162,500 412,500

1911 250,000 183,400 433,400

1912 250,000 195,400 445,400

1913 1 300,000 89,100 389,100

The business of the McClintic-Marshall Construction Co. was the fabrication and erection of structural steel. Its raw material was mostly steel shapes, plates, and bars, purchased from companies engaged in the general production of steel. Its work consisted of the fabrication and erection of the steel framework of office, mill, and factory buildings; train sheds; freight depots and terminals; pier sheds; *1030 warehouses; grandstands; drill halls; deck; through truss; cantilever and other types *753 of bridges and viaducts; turntables; ore trestles and bins; ore bridges; signal and catenary bridges; transmission poles and towers; coal bins; head frames; tipples; and numerous other types of buildings, structures, and engineering works. The type of business was such as to require a relatively small inventory or plant investment, as compared to a fully integrated steel company. The largest part of the company's raw material was the finished product of the steel companies that sold it to the McClintic-Marshall Construction Co. When it came to the shops of the latter, a large part of it was already of the proper length, shape, etc., to go into the particular job.

The Company fabricated and erected steel, but did little or no manufacturing. The erection or construction part of the business required a comparatively small investment, as the necessary field equipment was relatively small even on a large job. The Company's usual practice was to order the material after the contract had been obtained, and this practice permitted the material to be purchased in such forms, shapes, and dimensions as to require the minimum of shop work prior to the work of erection or construction on *754 the job site. The business was largely of a processing and engineering nature, and results depended much more on efficiency of personnel, perfection of organization, and high grade management than on the amount invested in physical properties. By March 1, 1913, the Company's personnel was well organized and experienced.

Except for a small minority interest outstanding at certain intervals, the common capital stock of the McClintic-Marshall Construction Co. was owned by the organizers in the following proportions: Petitioner, 30 percent; R. B. Mellon, 30 percent; H. H. McClintic, 20 percent; C. D. Marshall, 20 percent. On March 1, 1913, there were outstanding 30,600 shares of common stock, all of which was owned by the above persons except 500 shares owned by W. M. Sterrett. On said date there were outstanding 3,791 shares of preferred stock, 2,408 of which were owned by the four above stockholders. The remainder was owned by major employees holding responsible positions with the organization. The securities of the Company were not listed or dealt in on any exchange. Substantially the only dealings in the stock, at least prior to 1913, consisted of the issuance of common stock *755 at par, and the issuance and redemption of preferred stock at par or book value as hereinabove stated; and except that out of the 2,900 shares of preferred stock issued as a stock dividend to the common stockholders in 1908, 872 shares were transferred by the common stockholders to certain employees of the Company.

At all times from 1900 to 1913 the directors of the Company were A. W. Mellon, R. B. Mellon, C. D. Marshall, H. H. McClintic, and *1031 W. S. Mitchell; and the officers of the company were C. D. Marshall, president; H. H. McClintic, vice president; and W. S. Mitchell, secretary and treasurer. S. W. and R. B. Mellon were capitalists and bankers who had large financial resources both personally and by reason of their interest in and connection with important banking institutions. McClintic and Marshall were civil engineers, who, after graduation from Lehigh University in 1888, entered the employ of the Shiffler Bridge Co. From 1900 throughout their business lives they were the active managers of the business of the McClintic-Marshall Construction Co. and affiliated companies. During the period from 1900 to 1913 and thereafter, Marshall had direct supervision *756 of the administrative end and McClintic direct supervision of the production end of the business of McClintic-Marshall Construction Co.

From shortly after it was founded, the McClintic-Marshall Construction Co. determined upon, and consistently adhered to, a policy of using a substantial part of its earnings for growth and expansion. The amount distributed to stockholders was substantially increased after the common stock dividend of $2,760,000 was issued in December 1908. The rates and amounts of dividends paid are as follows: On common stock On preferred stock

Fiscal year ended Jan. 31 - Rate Amount Rate Amount

Per cent Per cent

1901 $2,177.76 $11,840.20

1902 None None

1903 27,747.48 57,361.24

1904 7 17,500.00 7 31,500.00

1905 7 17,500.00 7 31,500.00

1906 7 17,500.00 7 24,500.00

1907 7 17,500.00 7 24,500.00

1908 7 17,500.00 7 24,500.00

1909 7 114,100.00 7 27,448.65

Do ( 1 ) 2,760,000.00 ( 1 ) 290,000.00

1910 7 210,700.00 7 29,717.79

1911 7 210,700.00 7 33,044.56

1912 7 210,700.00 7 31,823.17

1913 None None 7 29,456.00

The *757 Company began business in 1900 with one plant, the bridge works at Pottstown, Pennsylvania, with a capacity of approximately 2,500 tons per month. An August 1900 a site was acquired at Rankin, Pennsylvania, and shop No. 1 was constructed on that site during 1901 and 1902. This shop had a capacity of about 3,500 tons per month. In 1906 additional land was acquired at that place and a new shop built, which brought the capacity of the Rankin plant to 7,500 tons per month. In 1907 the fabricating property and plant of the American Structural Steel Co. at Carnegie, Pennsylvania, was acquired, adding 1,000 tons per month to the capacity of the Company. By 1908 the total productive capacity had reached 12,000 *1032 tons per month. By March 1, 1913, the total capacity of the Companyy at its plants at Rankin, Pennsylvania, Pottstown, Pennsylvania, and Carnegie, Pennsylvania, had reached 12,800 tons per month, or 153,600 tons per year, of which 111,600 tons had been constructed new from 1902 to 1911. No plants or extensions were in process of erection on March 1, 1913.

The Company's shops were kept up to date and in excellent condition at all times. On March 1, 1913, an office *758 was maintained at each of the three plants, a general office was maintained at Pittsburgh, Pennsylvania, and sales offices were maintained at New York, Pittsburgh, Chicago, St. Louis, Detroit, Columbus, and San Francisco. The Company had also acquired in 1909 and continued to own on March 1, 1913, at Indiana Harbor near Chicago, a 50-acre site favorably located and appropriate for another plant whenever such plant expansion in the Chicago district should be decided upon.

While there were numerous concerns engaged in the structural steel business in competition with the McClintic-Marshall Construction Co., by the year 1908 it had become the second largest concern engaged in that business in the United States. The largest company engaged in that business was the American Bridge Co., a subsidiary of the United States Steel Corporation. Based on tonnage capacity and tonnage output, the American Bridge Co. was approximately five times as large as the McClintic-Marshall Construction Co. on March 1, 1913. At that time the capacity of the McClintic-Marshall Construction Co. was approximately twice that of its next largest competitor. Prior to March 1, 1913, the McClintic-Marshall Construction *759 Co. had fabricated and/or erected the structural steel for many structures, both large and small, and of many types of construction. By March 1, 1913, the Company had acquired a high reputation in the industry for the quality of its management, its efficiency of operation, and for ability to perform its contracts, however difficult the engineering or other problem involved.

Generally speaking, the Company used the accrual method of accounting, supplemented by the completed contract method with respect to its construction contracts. Its accounting period was the fiscal year ending January 31. The greater portion of its income was derived from contracts for the fabrication and erection of structural steel. Profits realized or losses sustained from the performance of such contracts were accounted for through its construction ledger. All costs, including material, labor, and overhead, were debited to accounts in that ledger. When bills were rendered for any portion of a contract price, the amounts were credited therein, with a corresponding charge to accounts receivable, and when collections were made the credit was to accounts receivable. Thus, at a given time, the construction *760 ledger reflected a debit balance or a credit balance, *1033 depending upon whether the costs exceeded the billings, or vice versa. The debit or credit balance in an account covering a particular contract was closed out to profit and loss during the period when the job had been completed and final settlement made with the other party to the contract. For balance sheet purposes, the net difference between the total debits and the total credits covering all open contracts carried in the construction ledger was reflected under the head of inventories. By this method, the construction ledger items or the inventory items contained in the various balance sheets reflect either a concealed profit or concealed loss, the nature and the exact amount of which could be determined only by a detailed analysis of all the open contracts.

Under date of June 21, 1910, the Company entered into a contract with the Isthmian Canal Commission to furnish and fabricate the material for and to erect the Panama Canal lock gates. This contract was obtained as the result of competitive bidding. There were four bids submitted, the approximate totals of which were as follows: McClintic-Marshall Construction Co $5,374,474.82

United States Steel Products Export Co. (affiliated with the American Bridge Co.) 6,103,041.10

Maryland Steel Co 8,409,369.31

Riter-Conley Manufacturing Co 10,183,257.00

*761 By the terms of the contract the exact contract price was determinable in accordance with the quantity of work done or material delivered and erected at specified unit prices. The contract required the furnishing and erection of 46 lock gates, 42 of which were to be completed on or prior to March 1, 1913, and the remaining four by June 1, 1913. On March 1, 1913, none of the gates had been completed. By supplemental contract dated May 20, 1913, the time for completion was extended to March 1, 1914. The greater part of the work in the Canal Zone was performed with native labor. McClintic-Marshall had never used native labor previously nor had it done any work in the tropics. The petitioner and his brother, R. B. Mellon, were jointly and severally sureties on the contract in the amount of $1,075,000. The fabrication work on the Panama Canal job, which was done at the No. 2 shop at Rankin, Pennsylvania, was begun in December 1910 and was completed in January 1913. On March 1, 1913, substantially all the materi

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