Clark, Associate Justice,*fn* Smith, Circuit Judge, and Zavatt, District Judge.*fn**
These are cross-appeals from a decision of the Tax Court, 54 T.C. 913 (1970), holding (1) that 26 U.S.C. § 482 (the Internal Revenue Code of 1954, hereinafter the "Code") did not authorize the Commissioner to allocate to B. Forman Co., Inc. (Forman) and McCurdy & Co., Inc. (McCurdy) (both referred to herein as taxpayers) interest income attributable to interest free loans made by the taxpayers to Midtown Holdings Corp. (Midtown), because of the absence of the requisite § 482 control of Midtown by the taxpayers; and (2) that annual payments of $75,000.00 each made by taxpayers to Midtown were not ordinary and necessary business expenses deductible under 26 U.S.C. § 162. The Commissioner appeals from the first of these holdings; the taxpayers appeal from the second. We reverse the decision of the Tax Court as to the first and affirm as to the second of these holdings.
These consolidated cases involve the corporate income tax liability of Forman and of McCurdy for the fiscal years 1965, 1966 and 1967. Having disallowed the annual payments of $75,000.00 each year by the taxpayers to Midtown and having allocated as income to each taxpayer interest at the rate of 5% per annum on a $1,000,000.00 loan made by each taxpayer to Midtown prior to the fiscal years in question, the Commissioner assessed tax deficiencies against each taxpayer (now in dispute) as follows:
1965 $62,425.55 $59,181.99
1967 59,692.00 62,343. 56
Totals $180,892.69 $181,169.47
Following receipt of the Commissioner's notices of these deficiencies and on January 31, 1969, each taxpayer filed a petition with the Tax Court for a review of the respective tax deficiency determinations of the Commissioner, both of which petitions were consolidated.
For several years prior to and as of the date of the incorporation of Midtown, McCurdy (a New York corporation since 1901) operated a retail general department store at 285 Main Street East, Rochester, New York and Forman (a New York corporation since 1912) operated a retail department store, specializing in men's and women's apparel, at 46 Clinton Avenue South, Rochester, New York. All of the stock of McCurdy was owned by or in behalf of members of the McCurdy family. All of the stock of Forman was owned by or in behalf of members of the Forman family. McCurdy and Forman had no common shareholders, directors or officers. Both corporations were competitors.
In an effort to stem declining incomes, McCurdy and Forman caused Midtown to be formed in 1958. On March 23, 1959 they entered into an agreement with reference to their participation in the building and development of a midtown shopping center in Rochester which would adjoin the rear entrances to their respective stores. By that time the Board of Directors and officers of Midtown consisted of the following:
Gilbert J. C. McCurdy -- Chairman of the Board
(President and Chairman of Directors and Presi-
of Board of Directors dent of McCurdy
Gordon W. McCurdy -- Vice-Chairman of the
(Secretary and a Board of Directors and
Director of Midtown) Senior Vice-President of
Maurice R. Forman -- Chairman of the Board
(Vice-President and a of Directors and Presi-
Director of Midtown) dent of Forman
Fred Forman -- Member of the Board
(Treasurer and a of Directors and Senior
Director of Midtown) Vice-President of For-
It would appear from that agreement that when, in 1958, McCurdy and Forman decided to form Midtown and erect a shopping center in downtown Rochester, they each entered into lease agreements (with options to purchase) with the owners of the property on which they contemplated the construction of the shopping center. These properties are described in the appendices to the agreement of March 23, 1959. In and by that agreement McCurdy and Forman agreed to assign and transfer to Midtown their respective interests in these leases and options and to convey title to any such property already vested.
McCurdy and Forman had already acquired 50% each of the issued and outstanding shares of Midtown. In exchange for the real estate interests they were to assign and convey to Midtown, each of them was to receive an additional 810 common, no par value shares of Midtown, thus continuing their equal stock ownership in Midtown. If, prior to January 1, 1965, the Board of Directors of Midtown should determine, by resolution, that additional funds were necessary or advisable, McCurdy and Forman agreed to purchase additional shares of Midtown "so that their aggregate holding shall be One Million Dollars ($1,000,000) each, at any time, and from time to time . . ." In addition, each party to this agreement agreed to loan to Midtown additional amounts
"so that their aggregate loans to Midtown shall be One Million Dollars ($1,000,000) each, at any time and from time to time, if, prior to January 1, 1965, the Board of Directors of Midtown, by resolution, shall determine that such additional funds in the form of borrowing are necessary or advisable. Loans shall be made equally by the parties.
Such loans shall be represented by notes, or other evidence of indebtedness, of Midtown, the essential features of which shall be as follows:
(A) The notes shall pay interest at the rate of five (5) percent per annum, payable semi-annually on the first day of January and July in each year.
(B) The notes shall be due and payable thirty (30) years after issuance.
(C) Midtown shall have the right to prepay the notes in whole or in part on any interest paying date prior to maturity upon the payment of the ...