James
v.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
Tax Court of the United States.Apr 30, 1951
16 T.C. 930 (U.S.T.C. 1951)

Docket Nos. 25697 25698 25699 25700 25702 25703 25704.

1951-04-30

EDWARD C. JAMES, ET AL.,1 PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Murray G. Smyth, Esq., Harry L. Jones, Esq., and Felix T. Terry, C.P.A., for the petitioners. F. S. Gettle, Esq., for the respondent.


Murray G. Smyth, Esq., Harry L. Jones, Esq., and Felix T. Terry, C.P.A., for the petitioners. F. S. Gettle, Esq., for the respondent.

On August 1, 1945, petitioners Edward C. James, L. L. Gerdes, and Harry P. Wayman, Jr., entered into an agreement wherein James purported to sell and Gerdes and Wayman each purported to buy for $100,000 a one-third interest in the selling organization of James' venetian blind business, the net assets of which consisted mostly of good will and a list of customers. The earnings of the business were to be shared equally; however, Gerdes' and Wayman's earnings were to be applied against their indebtedness to James. James retained complete control of the business and on July 31, 1947, after both Wayman and Gerdes had ‘paid‘ approximately $40,000 against their indebtedness to James out of the part of earnings credited to their accounts, the agreement of August 1, 1945, was terminated and the entire business reverted to James for the mere cancellation of the balance of Gerdes' and Wayman's indebtedness to him. Held, during the period from August 1, 1945, to July 31, 1947, petitioners James, Wayman, and Gerdes did not operate a business as a partnership and the entire income of the Consolidated Venetian Blind Co. is taxable to James on a community property basis.

These proceedings have been consolidated.

Respondent has determined deficiencies in income taxes as follows:

+-------------------------------------------------------------------------+ ¦ ¦ ¦Deficiency ¦ +--------------------------------------------+------+---------------------¦ ¦Petitioner ¦Docket¦ ¦ +--------------------------------------------+------+---------------------¦ ¦ ¦No. ¦ ¦ ¦ +--------------------------------------------+------+----------+----------¦ ¦ ¦ ¦1945 ¦1946 ¦ +--------------------------------------------+------+----------+----------¦ ¦Edward C. James ¦25697 ¦$11,198.55¦$12,645.17¦ +--------------------------------------------+------+----------+----------¦ ¦Evelyn (Mrs. Edward C.) James ¦25698 ¦11,248.54 ¦12,763.92 ¦ +--------------------------------------------+------+----------+----------¦ ¦L. L. Gerdes ¦25699 ¦91.89 ¦3,764.23 ¦ +--------------------------------------------+------+----------+----------¦ ¦Ruth Maxine (Mrs. L. L.) Gerdes ¦25700 ¦11.15 ¦3,875.43 ¦ +--------------------------------------------+------+----------+----------¦ ¦Harry P. Wayman, Jr ¦25702 ¦ ¦3,956.01 ¦ +--------------------------------------------+------+----------+----------¦ ¦Harry P. Wayman, Jr., Jennie M. Wayman, Wife¦25703 ¦69.00 ¦ ¦ +--------------------------------------------+------+----------+----------¦ ¦Jennie (Mrs. Harry P., Jr.) Wayman ¦25704 ¦ ¦3,956.01 ¦ +-------------------------------------------------------------------------+

Petitioners have conceded the correctness of respondent's adjustments to their net incomes, except as to those adjustments relating to the partnership which petitioners claim existed among Edward C. James, L. L. Gerdes, and Harry P. Wayman, Jr. In the deficiency notice sent to Edward C. James for the year 1945, this adjustment was explained as follows:

(3) As previously stated, the alleged partnership, Consolidated Venetian Blind Company, is not recognized for tax purposes and the income of the so-called partnership is taxable to you.

Respondent admits that he has taken inconsistent positions in the determination of the deficiencies herein by not recognizing the partnership in so far as James is concerned and by recognizing it to the extent of including one-third of the ‘partnership‘ income in Gerdes' and Wayman's incomes. Respondent concedes that if we should hold against the validity of the partnership then the amount of partnership profits reported in Gerdes' and Wayman's returns in 1946 should be eliminated. None was reported in their returns for 1945. He concedes that the same income cannot be taxed to James and at the same time taxed to Gerdes and Wayman.

By appropriate assignments of error petitioners contest respondent's determination that there was no valid partnership between James, Gerdes and Wayman.

FINDINGS OF FACT.

Petitioners are residents of Houston, Texas. Edward C. James and Evelyn James are husband and wife; L. L. Gerdes and Ruth Maxine Gerdes are husband and wife; and Harry P. Wayman, Jr., and Jennie M. Wayman are husband and wife. Except for the year 1945 when petitioners Harry P. Wayman, Jr., and Jennie M. Wayman filed a joint return, each of the petitioners filed individual returns for the years 1945 and 1946 on a community property basis. All of the returns were filed with the collector of internal revenue for the first district of Texas. Since the only issue herein involves Edward C. James, L. L. Gerdes and Harry P. Wayman, Jr., they will for the sake of convenience be referred to collectively as petitioners.

Edward C. James started in the venetian blind business in the form of a partnership on or about January 1, 1938; James later bought out his partner's interest and conducted the business as a sole proprietorship which manufactured and sold venetian blinds. On January 18, 1944, the manufacturing end of the business was incorporated as Consolidated Venetian Blind Co., Inc. (hereinafter called the corporation) but the selling end of the business was continued as a sole proprietorship. While so operating the selling end of the business James entered into a written contract with the corporation which provided that the corporation agreed to sell and the proprietorship agreed to buy the entire output of the corporation.

Gerdes first became associated with James in the venetian blind business in 1939. Gerdes handled the books, the credits, accounting and administration, was office manager and handled necessary reports and other statistical parts of the business. During the war Gerdes took care of priorities. Gerdes' compensation was on the basis of a fixed salary.

Wayman became associated with James in the Spring of 1940. Wayman had considerable experience in the venetian blind business prior to the time he became associated with James and had contacts with valuable customers. Wayman handled all of the sales, helped with the general administration of the business, as well as the advertising and general promotion of the venetian blind business. Wayman has been with the selling end of the organization continuously since he first became associated with James. His compensation was on a commission basis.

For some time prior to August 1, 1945, Wayman and Gerdes felt that they were entitled to a greater share in the business which they had a hand in developing. Wayman and Gerdes had opportunities to leave James and take employment with better financial rewards, but they remained with James. After several weeks of discussion between themselves, Wayman and Gerdes approached James concerning the formation of a partnership with respect to the selling end of the business so that they might participate as co-owners and share in the profits rather than continue as employees.

The largest account of the sales department was with Sears Roebuck & Company which account Wayman brought to the business. The Sears Roebuck & Company account represented, roughly 50 per cent to 60 per cent of the volume of business of the sales organization. The sales organization had only a small amount of tangible assets, and such assets as it did have consisted for the most part of services rendered, good will and lists of customers. Personal services and salesmanship were the principal activities of the sales organization.

Wayman was particularly interested in acquiring an interest in the selling end of the business, rather than in the manufacturing end. Having little money, he did not feel that he could expect to buy stock, but, in view of the services he had to offer, did feel that he could work out an agreement with James on the selling end of the business.

James did not feel that he could afford to lose either Wayman or Gerdes as they had an important part in the success of the business and James considered it of great importance to the business to retain them. Wayman and Gerdes were willing for James to be the controlling head of the business as they considered that to be to their benefit. Neither Wayman nor Gerdes had any substantial money to invest in the business.

On August 1, 1945, James, Wayman and Gerdes executed an instrument the material provisions of which are as follows:

WHEREAS, the undersigned, Edward C. James, a resident of Harris County, Texas, is operating a business under the name of Consolidated Venetian Blind Co., and each of the undersigned H. P. Wayman, Jr. and L. L. Gerdes, desires to purchase an interest therein, and the parties have agreed as follows:

NOW, THEREFORE, KNOW ALL MEN BY THESE PRESENTS:

That in consideration of the sum of One Hundred thousand Dollars ($100,000.00) paid and to be paid by each of the said H. P. Wayman, Jr. and L. L. Gerdes, the amount paid by each being one hundred Dollars ($100.00), and the amount to be paid by each being Ninety-nine thousand, nine hundred Dollars ($99,900.00) evidenced by a promissory note as hereinafter set out, the said Edward C. James hereby sells, transfers and delivers to each of said parties an undivided one-third interest in said business, a going concern, and in all of the assets thereof, tangible and intangible, including good will.

And that they, the said purchasers, have each executed and delivered to the said Edward C. James a promissory note, above referred to, reading (except for the signatures) as follows (this being the instrument referred to in the last paragraph of said note):

$99,900.00 Houston, Texas, August 1, 1945.

For value received, I, the undersigned, promise to pay to Edward C. James, or order, Ninety-nine thousand, nine hundred dollars ($99,900.00), at Houston, in Harris County, Texas, in annual installments. The installment for the first year shall equal the undersigned's one-third interest in the net earnings of Consolidated Venetian Blind Co., a partnership, of Houston, Texas, for such year, less only such sum as may be necessary to pay that portion of the undersigned's total federal income taxes for that year occasioned by the undersigned's proprietary interest in the said partnership, provided that said installment shall in no event exceed Twenty-nine thousand, nine hundred Dollars ($29,900.00). Said installment shall be due and payable on July 31, 1946. Subsequent installments shall be due and payable annually thereafter and for each year, until this note is paid in full, shall equal and shall accrue in the amount of and to the full extent of the undersigned's one-third interest in the net earnings of said partnership for such year, less only such sum as may be necessary to pay the portion of the undersigned's total federal income taxes for that year occasioned by the undersigned's proprietary interest in the partnership. Termination of said partnership shall automatically release the maker of this note from all personal liability for the balance then unaccrued on this note.

This note is secured by the vendor's lien retained in and by an assignment of earnings as stipulated in an instrument of this date evidencing the sale and transfer above referred to.

(Signature)

The said Edward C. James retains the vendor's lien upon the respective interests herein conveyed to the said H. P. Wayman, Jr. and L. L. Gerdes, to secure the payment of their respective notes and each of the said parties hereby assigns to the said Edward C. James such of his portion of the earnings upon his interest in and said partnership as may be necessary to pay his said note.

Pursuant to the foregoing, the persons named, that is, the said Edward C. James, H. P. Wayman, Jr. and L. L. Gerdes, hereby agree to be and hereby constitute themselves partners in the business of selling the products of Consolidated Venetian Blind Co., Inc., under the firm name of Consolidated Venetian Blind Co., for the term of 5 years, and no more, commencing on the 1st day of August, 1945, and ending on the 31st day of July, 1950, subject to earlier termination as hereinafter provided, and upon terms and conditions as follows:

Net profits shall be shared in proportion to the respective interests of the parties in the partnership. Edward C. James agrees to indemnify each other party hereto against any net loss ever incurred by such party by virtue of such party's partnership liability to persons not parties to this agreement, in so far as such liability may grow out of the partnership relation created by this agreement and exceeds such party's interest in the assets of the business and his then past total receipts from the business and provided that such liability or loss shall at all times be a primary charge against the business and against such party's interest in the assets of the partnership and in the past, current and future earnings thereof.

The said Edward C. James shall at all times and in all things be the sole and exclusive manager of the partnership and its business and sole custodian and manager of its properties, and shall at all times and in all things be the sole custodian of its books, papers and writings of every kind, and shall at all times and in all things be vested with full, unlimited, unconditional, irrevocable, and exclusive power and authority. The other partners shall have no power to and agree not to undertake to bind the partnership or any other partner or to act for the partnership or any other partner in any respect. The salary of Edward C. James is temporarily fixed at $300.00 per month and all other salaries shall continue at the figures now shown on the books of the business, provided, however, that Edward C. James may at any time, and as often as he sees fit, increase or reduce any salary, either his own or the salary of any other party hereto, or of any other persons.

* * * 10*

Anything to the contrary notwithstanding, the partnership shall terminate completely, without limitation or condition, in the event of the cancellation or other termination of the contract dated August 1, 1945, between the partnership and Consolidated Venetian Blind Co., Inc., by whatever party cancelled or however terminated.

* * * 10*

* * * In the event of the complete termination of the partnership, for whatever reason, or however terminated, all of the assets of the partnership, except the firm name, shall be liquidated and the proceeds shall be distributed to the partners, according to their respective interests, provided that if there then be any indebtedness by any partner to Edward C. James, upon the aforesaid note or otherwise, enough of such partner's interest in such distribution to pay said indebtedness shall be paid direct to the said Edward C. James, anything hereinabove or hereinafter or in said promissory notes to the contrary notwithstanding. In the event of the cancellation of the said contract with Consolidated Venetian Blind Co., Inc., by whatever party cancelled, and regardless when such cancellation may take place, or in the event of the complete termination of the partnership for whatever reason, or however terminated, the firm name shall automatically vest in the said Edward C. James, or if he be not living, then the firm name in such event or events shall automatically vest in his heirs or devisees, as the case may be, all and in any and every case without compensation, liability or responsibility to anyone.

Any partner, other than the said Edward C. James shall have the right at any time to withdraw from the partnership by giving 10 days notice, preceding the end of any calendar month, in writing to the other partners. Such withdrawal and also any breach of any of the provisions hereof by either of said H. P. Wayman, Jr., or L. L. Gerdes, shall, at the option of Edward C. James, automatically forfeit the interest in the partnership and its assets of the one so withdrawing or committing such breach and such interest shall, upon his declaration of such forfeiture, thereupon forthwith vest in the said Edward C. James.

The partnership balance sheet and capital account, upon formation of the partnership, stood as follows:

+---------------------------------------------+ ¦Assets: ¦ ¦ +----------------------------------+----------¦ ¦Cash ¦$35,284.42¦ +----------------------------------+----------¦ ¦Accounts receivable ¦25,261.55 ¦ +----------------------------------+----------¦ ¦Suspense account ¦50.00 ¦ +----------------------------------+----------¦ ¦Total ¦$60,595.97¦ +----------------------------------+----------¦ ¦Liabilities: ¦ ¦ +----------------------------------+----------¦ ¦Harry P. Wayman, Jr. (commissions)¦$143.21 ¦ +----------------------------------+----------¦ ¦Accounts payable (trade) ¦39,919.89 ¦ +----------------------------------+----------¦ ¦Due Edward C. James ¦17,158.82 ¦ +----------------------------------+----------¦ ¦Reserve for bad debts ¦1,874.05 ¦ +----------------------------------+----------¦ ¦Capital: ¦ ¦ +----------------------------------+----------¦ ¦Edward C. James ¦$500.00 ¦ +----------------------------------+----------¦ ¦Harry P. Wayman, Jr ¦500.00 ¦ +----------------------------------+----------¦ ¦L. L. Gerdes ¦500.00 ¦ +----------------------------------+----------¦ ¦Total ¦$60,595.97¦ +---------------------------------------------+

Under the date of September 30, 1945, James wrote letters to Wayman and Gerdes wherein James modified the agreement of August 1, 1945. In these letters which were attached to the original agreement James gave Wayman and Gerdes authority to receive from Consolidated Venetian Blind Co. cash in a sum not to exceed $1,000 for the year ending July 31, 1946, and a sum not to exceed $2,000 for each of the next four fiscal years ending July 31.

At the time the instrument of August 1, 1945 was executed, James, Wayman, and Gerdes expected the earnings of the venetian blind business to increase substantially in the future. The total sales and net profits from the venetian blind business conducted by James as a sole proprietorship for the years 1940 to 1943, inclusive, were as follows:

+--------------------------------+ ¦ ¦Total sales ¦Net profits ¦ +----+-------------+-------------¦ ¦1940¦$369,877.51 ¦$74,172.42 ¦ +----+-------------+-------------¦ ¦1941¦538,908.09 ¦83,600.10 ¦ +----+-------------+-------------¦ ¦1942¦431,416.54 ¦35,493.66 ¦ +----+-------------+-------------¦ ¦1943¦482,566.86 ¦36,877.61 ¦ +--------------------------------+

Total sales and net profits of Consolidated Venetian Blind Company, Inc., for the year 1944, were as follows:

+--------------------------------+ ¦ ¦Total sales ¦Net profits ¦ +----+-------------+-------------¦ ¦1944¦$533,120.18 ¦$57,739.92 ¦ +--------------------------------+

Total sales and net profits of the sales organization referred to in the instrument of August 1, 1945, for the years 1945 and 1946 were as follows:

+--------------------------------+ ¦ ¦Total sales ¦Net profits ¦ +----+-------------+-------------¦ ¦1945¦$764,872.56 ¦$95,950.18 ¦ +----+-------------+-------------¦ ¦1946¦1,028,937.36 ¦94,980.09 ¦ +--------------------------------+

The corporation, Consolidated Venetian Blind Company, Inc., kept its books on a fiscal year basis. Operations for the fiscal years ended June 30, 1945, 1946 and 1947, were as follows:

+--------------------------------+ ¦ ¦Sales ¦Net profits ¦ +----+------------+--------------¦ ¦1945¦$577,511.82 ¦$13,493.70 ¦ +----+------------+--------------¦ ¦1946¦583,917.86 ¦16,726.30 ¦ +----+------------+--------------¦ ¦1947¦1,161,626.93¦102,329.91 ¦ +--------------------------------+

World War II had its effect on the venetian blind business due to the fact that the supply of materials and all metals were scarce. During the war years a substantial backlog of orders was built up. After the war, controls over metals were removed and Consolidated Venetian Blind Company, Inc., greatly increased its manufacture of blinds thereby filling many back orders which increased its sales and net profits.

During the years 1945 and 1946 Wayman withdrew from the earnings of the sales organization amounts as follows:

+-------------------------------------+ ¦ ¦1945 ¦1946 ¦ +---------------------+-------+-------¦ ¦Personal use ¦$300.00¦$920.00¦ +---------------------+-------+-------¦ ¦Payment of income tax¦ ¦820.00 ¦ +-------------------------------------+

During the years 1945 and 1946 Gerdes withdrew from the earnings of the sales organization amounts as follows:

+---------------------------------------+ ¦ ¦1945 ¦1946 ¦ +---------------------+-------+---------¦ ¦Personal use ¦$300.00¦$1,100.00¦ +---------------------+-------+---------¦ ¦Payment of income tax¦ ¦785.00 ¦ +---------------------------------------+

The capital stock of Consolidated Venetian Blind Company, Inc., was issued and held during the taxable years in question, as follows:

+------------------------------+ ¦ ¦Shares ¦ +---------------------+--------¦ ¦Edward C. James ¦3,998 ¦ +---------------------+--------¦ ¦Mrs. Edward C. James ¦1 ¦ +---------------------+--------¦ ¦L. L. Gerdes ¦1 ¦ +---------------------+--------¦ ¦Total ¦4,000 ¦ +------------------------------+

The sales organization provided for under the instrument of August 1, 1945, was terminated on July 31, 1947. The instrument terminating the agreement of August 1, 1945, is as follows:

It is agreed between EDWARD C. JAMES, H. P. WAYMAN, JR., and L. L. GERDES that the partnership entitled CONSOLIDATED VENETIAN BLIND CO., in which they are the sole partners, be and the same is hereby terminated. The unpaid balance on the promissory note for $99,900.00, dated August 1, 1945, and executed to Edward C. James by H. P. Wayman, Jr., and the unpaid balance on the promissory note for $99,900.00 dated August 1, 1945, and executed to Edward C. James by L. L. Gerdes, are cancelled, and the said Edward C. James hereby assumes all liabilities of the partnership in full, in consideration of all of which the said H. P. Wayman and L. L. Gerdes each hereby assign and transfer to the said Edward C. James their respective interests in all of the assets of said partnership, including the firm name.

The partnership agreement entered into by the parties hereto on August 1, 1945, is hereby terminated and declared of no further force and effect.

Executed in equal triplicate originals, this 31 day of July 1947, one executed copy being delivered to H. P. Wayman, Jr., one to L. L. Gerdes, and one to Edward C. James.

On the books of Consolidated Venetian Blind Co. all the profits were credited to the capital accounts of the respective petitioners and all withdrawals were charged against the capital accounts. Wayman and Gerdes received part in cash, the balance being credited on their notes as agreed. The money that James received on the notes was considered as capital gain from the sale of the partnership interests and was so reported by James, without a cost basis except for $1,000 cost of net assets transferred.

A partnership bank account was set up and checked on by Wayman and Gerdes separately in limited amounts, and was checked on by them jointly in unlimited amounts.

In 1947, the instrument of August 1, 1945, was questioned as to its legal effect for income tax purposes by internal revenue agents and, after a discussion of the matter, the interested parties terminated the sales organization by the instrument dated July 31, 1947, which has been copied above. At the time the sales arrangement was terminated, the distribution of profits from the organization which had been allocated to Wayman and applied as payments on the notes were released to James. Wayman got nothing back.

During the fiscal year ended July 31, 1946, the note which Wayman executed in favor of James in connection with the agreement of August 1, 1945, was credited with the amount of $20,743.25. During the fiscal year ended July 31, 1947, the note was credited with the amount of $19,995.10. These credits represented an allocation of the profits from the sales organization. The total of these two amounts is $40,738.35.

At the time the sales arrangement was terminated, the distribution of profits from the organization which had been allocated to Gerdes and which had been applied as payments on his notes were released to James. Gerdes got nothing back. For the fiscal year ended July 31, 1946, the amount of $21,024 which was part of the distribution of the selling organization's profits was credited to the reduction of the note which Gerdes signed in favor of James. For the fiscal year ended July 31, 1947, the amount of $18,992.51 which was credited to Gerdes was credited to the reduction of the note. The total of these two amounts is $40,016.51.

The money received by James from Wayman and Gerdes were reported in his 1945 and 1946 Federal income tax returns as an installment sale of an interest in the venetian blind business and was reported as capital gain. On his 1946 return in addition to these capital gains, James reported among other items of community income the following: ‘Partnership Income— Consolidated Venetian Blind Company $29,153.34.‘ For the taxable year 1945, James reported income as long term capital gain from the transaction arranged under the agreement of August 1, 1945, as follows:

+---------------------------------------------------------------+ ¦Sales price ¦$200,000.00¦ +---------------------------------------------------+-----------¦ ¦Cost of assets ¦1,000.00 ¦ +---------------------------------------------------+-----------¦ ¦ ¦ ¦ +---------------------------------------------------+-----------¦ ¦Gross profit ¦199,000.00 ¦ +---------------------------------------------------+-----------¦ ¦Cash received in 1945 ¦$200.00 ¦ +---------------------------------------------------+-----------¦ ¦$199,000.00 x $200.00 ¦ ¦ +---------------------------------------------------+-----------¦ ¦--------------------- = $199.00 ¦ ¦ +---------------------------------------------------+-----------¦ ¦$200,000.00 ¦ ¦ +---------------------------------------------------+-----------¦ ¦Long term capital gain = 50% of $199.00, or $99.50.¦ ¦ +---------------------------------------------------------------+

For the taxable year 1946, James reported income from the transaction as capital gain as follows:

+--------------------------------------------------+ ¦Sales price ¦$200,000.00¦ +--------------------------------------+-----------¦ ¦Cost of assets ¦1,000.00 ¦ +--------------------------------------+-----------¦ ¦ ¦ ¦ +--------------------------------------+-----------¦ ¦Gross profit ¦199,000.00 ¦ +--------------------------------------+-----------¦ ¦Profits reported in 1945 ¦199.00 ¦ +--------------------------------------+-----------¦ ¦ ¦ ¦ +--------------------------------------+-----------¦ ¦Unrecovered profit ¦198,801.00 ¦ +--------------------------------------+-----------¦ ¦Cash received in 1946 ¦50,889.93 ¦ +--------------------------------------+-----------¦ ¦$199,000.00 ¦ ¦ +--------------------------------------+-----------¦ ¦----------- x $50,889.93 or $50,635.48¦ ¦ +--------------------------------------+-----------¦ ¦$200,000.00 ¦ ¦ +--------------------------------------+-----------¦ ¦50% of $50,635.48 = $25,317.74 ¦ ¦ +--------------------------------------------------+

The selling organization, called Consolidated Venetian Blind Co., set up by James, Wayman, and Gerdes under the agreement of August 1, 1945, was not a partnership under the Internal Revenue Code and the profits of the selling organization are taxable to the petitioners Edward C. James and Evelyn James in 1945 and 1946 on a community basis.

The amounts of cash paid to petitioners Wayman and Gerdes during the taxable years 1945 and 1946 by the selling organization, called Consolidated Venetian Blind Co. represent compensation for services rendered and not distributions of profits from a partnership.

OPINION.

BLACK, Judge:

In these proceedings we have but one issue to decide: During the period from August 1, 1945, to July 31, 1947, did petitioners Edward C. James, L. L. Gerdes and Harry P. Wayman, Jr., operate the business of Consolidated Venetian Blind Co. as a partnership within the meaning of section 3797 of the Internal Revenue Code?

SEC. 3797. DEFINITIONS.(a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof—(2) PARTNERSHIP AND PARTNER.— The term ‘partnership‘ includes a syndicate, group, any business, financial operation, or venture is carried on, and which is not, within the meaning of this title, a trust or estate or a corporation; and the term ‘partner‘ includes a member in such a syndicate, group, pool, joint venture, or organization.

A partnership is generally defined as a joining together the money, goods, labor, or skill of two or more persons for the purpose of carrying on a business and sharing in the profits or losses or both. Commissioner v. Tower, 327 U.S. 280; Ward v. Thompson, 22 How. 330, 166 L.Ed. 249.

Although these proceedings do not involve an intrafamily agreement as in Commissioner v. Culbertson, 337 U.S. 733, the general test to be applied in determining the validity of an alleged partnership within the meaning of the Revenue Code is set out in that case wherein the Court said:

The question is not whether the services or capital contributed by a partner are a sufficient importance to meet some objective standard supposedly established by the Tower case, but whether, considering all the facts— the agreement, the conduct of the parties in execution of its provisions, their statements, the testimony of disinterested persons, the relationship of the parties, their respective abilities and capital contributions, the actual control of income and the purposes for which it is used, and any other facts throwing light on their true intent— the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise. * * *

We think that petitioners James, Gerdes, and Wayman were not partners during the period from August 1, 1945, to July 31, 1947. The agreement and the conduct of the parties in the instant proceedings are much like the following situation described in Story on Partnership, 7th Edition, section 18:

* * * If the contract be for the sole and exclusive benefit of one party, it is not properly a case of partnership, but must fall under some other denomination, such as a mandate. Hence, if, in a pretended contract of partnership, it should be agreed that one of the parties should take all the profit, without the others having any share thereof, it would be a mere nullity, and constitute no partnership. The Roman jurists branded such a contract with the odious epithet of Societas Leonina, in allusion to the fable of the lion, who having entered into a partnership with the other wild beasts for hunting, appropriated the whole prey to himself. * * *

The one-sidedness of the arrangement in the instant proceeding is evidenced by some of the following factors, none of which alone perhaps would be sufficient to find that petitioners were not partners but all of which together requires us, we think, to find that petitioners were not partners. James was the controlling head of the business; he agrees to indemnify Gerdes and Wayman for all losses occasioned by the agreement. James as controlling stockholder of the corporation could have, without further responsibility to Gerdes and Wayman, cancelled the agreement between the corporation and Consolidated Venetian Blind Co. and thus terminated the ‘partnership.‘

The net assets of the sales organization consisted mostly of good will, services rendered, and lists of customers. In the agreement of August 1, 1945, James purported to sell both Gerdes and Wayman a one-third interest in that business for the sum of $100,000 each and upon which two-thirds interest James claimed as his basis $1,000. For their respective one-third interest Gerdes and Wayman paid $100 in cash to James and each signed a note in the amount of $99,900 payable to James. Each of the petitioners was to be entitled to one-third of the profits of the business. Unless earlier terminated, the business was to be conducted for a period of 5 years.

The agreement provided that Wayman's and Gerdes' one-third share of Consolidated Venetian Blind Co.'s earnings should be applied against their indebtedness to James, less such sums as may be necessary to pay their individual Federal income taxes occasioned by their share of these earnings. James amended the original agreement to allow Gerdes and Wayman the privilege of withdrawing cash in an amount not to exceed $1,000 for the first year and $2,000 for the next 4 years.

In 1947, when the alleged partnership was terminated by agreement of petitioners, Gerdes and Wayman released their one-third interests to James for nothing more than the cancellation of their indebtedness to James. At that time a one-third interest in Consolidated Venetian Blind Co. would seem to have been under the evidence worth fully as much as it was on August 1, 1945, and the earnings and profits of the business were expected to, and did, increase in the subsequent years. Both Gerdes and Wayman had paid James approximately $40,000 of the $100,000 agreed on for a one-third interest in Consolidated Venetian Blind Co., and yet they relinquished their interests for the mere cancellation of the balance due on their notes to James. None of the $40,000 which each had paid in the manner detailed in our findings of fact was returned to them.

Considering the agreement and the operation of the business and the cancellation of the agreement without attending benefit to Gerdes and Wayman, we cannot find that during the period from August 1, 1945, to July 31, 1947, petitioners were partners. In our view, there was not a valid partnership within the meaning of the Internal Revenue Code and the entire income of Consolidated Venetian Blind Co. is taxable to James on a community property basis.

In his determinations of the net incomes of Edward C. James and Evelyn James respondent has allowed as a business expense the amounts actually paid to Gerdes and Wayman. These allowed deductions will remain undisturbed in a computation under Rule 50. Respondent concedes that if, as we have found, no partnership was in existence the income from Consolidated Venetian Blind Co. cannot be taxed to petitioners Wayman and Gerdes as respondent determined in his deficiency notices.

Decisions will be entered under Rule 50.