Ferguson v. Commissioner

*12 Respondent determined an income tax deficiency against petitioner, *33 Joseph B. Ferguson, for the year 1959 in the amount of $ 1,191.52. In various amendments to his answer filed herein, respondent asserted certain increased deficiencies totaling in excess of $ 310,000.

After various concessions by respondent at trial and on brief, the only questions remaining for decision are: (1) Whether certain payments totaling $ 132,592 made by Fergus Imported Cars, Inc., in 1959 represented taxable income to petitioner, and (2) whether interest income earned in 1959 by funds on deposit in a certain savings account was taxable to petitioner.

FINDINGS OF FACT

Some of the facts have been stipulated in writing, and some by oral stipulation at trial. All stipulated facts are incorporated herein by this reference.

Petitioner is an individual residing at 1717 Broadway in New York City. His Federal income tax return for the taxable year 1959 was filed with the district director, Manhattan, N.Y.

Petitioner is judicially separated from his wife pursuant to a final judgment, dated April 21, 1941, entered in a New York State court. Since 1941 petitioner has been in court many times in controversies *13 with his wife concerning the amount of alimony to be paid to *34 her. Sometime prior to the tax year here in question petitioner opened and thereafter used a bank account in the name of his deceased brother. This name was used so that petitioner's wife would not know of the account's existence.

Petitioner was born in 1880 near Belfast, Northern Ireland. As a youngster he was interested in mechanics and farm machinery, and at age 15 he began working in a Belfast machine shop, where he remained employed for 6 years. He left this apprenticeship in 1901 and opened his own mechanical repair shop. At this time the automobile was in its infancy and there were very few of them in Belfast. Petitioner took a keen interest in the then modern wonder of motor-driven vehicles, and his repair shop specialized in work on motorcycles and automobiles. In 1906 petitioner joined with his brother in opening up a larger shop so that they could get into the business of buying and selling cars on a bigger scale than theretofore.

Through several years of experience, petitioner and his brother became familiar with the mechanical and engineering shortcomings of the early automobiles, and they developed several improvements, on many of which they acquired patents. *35 In 1914 they began construction of a new automobile, incorporating many of their improvements into what they thought would be the "ideal car." This new car, called the Fergus, had the following improvements over its contemporaries: The lubrication points were cut from 70 to about 10; the engine was suspended in rubber rather than attached directly to the frame, thus reducing vibration; the engine was smaller, yet developed more power than conventional engines; it had overhead valves rather than side valves.

The new Fergus received substantial publicity and in 1915 petitioner arranged to bring the car to the United States for a public exhibition at the Grand Central Palace in New York. As a result of this exhibit petitioner received backing from certain New York interests and a new corporation was formed in 1916, with a factory in Newark, N.J., to manufacture and improve the Fergus car. This corporation was called Fergus Motors of America, Inc. During and after the First World War, this corporation, led by petitioner, was called upon by the U.S. Government to carry out various developmental projects, primarily involving improvements in aircraft engines. Fergus Motors of America, *36 Inc., received a citation from the War Department of the United States for distinguished service aiding materially in obtaining victory for the arms of the United States in World War I.

After the war, petitioner and his colleagues returned their attention to automobiles, and in 1921 they introduced at the Motor Sports Show *14 in New York, a new, improved model of the Fergus. This car was an improvement on the original 1914 Irish Fergus in that it contained a 6-cylinder engine instead of a 4-cylinder one, and it further decreased the number of lubrication points. The 1921 model was the first car ever to employ a thermostatically controlled automatic choke on the carburetor. The 1921 Fergus was advertised at $ 10,000, complete chassis only, f.o.b. Newark, with a 5-year comprehensive guarantee.

During his early years in America, petitioner was consulted by others in the automotive industry concerning various improvements which he and/or Fergus Motors of America, Inc., had developed. Chrysler Corp. paid for consultation concerning the rubber mounting of the automobile engine as originated on the 1914 Irish Fergus. Petitioner and his company did all the front suspension work*37 on the Cord automobile. In a patent-infringement suit concerning an automatic choke carburetor petitioner was paid by General Motors and other defendants to appear as a defense witness and testify that he had displayed such a carburetor in the 1921 exhibit of the original Fergus, 10 years prior to the date the plaintiff in the case claimed to have invented it.

In 1940 petitioner formed Fergus Motors, Inc., a New York corporation (herein called Fergus Motors), and for many years prior to June 29, 1955, he was the sole owner of its stock and was its president. Fergus Motors was engaged primarily in the business of buying, selling, and servicing foreign cars. In their spare time, particularly on Saturdays, petitioner and some of the Fergus Motors employees would engage in experimental work on automobiles. Petitioner was also, for many years prior to June 29, 1955, the owner of all of the stock of 444 West 55th Street Corp., a New York corporation (herein called 444), which on that date owned three parcels of improved commercial real property as follows:

(a) 1717 Broadway, New York City (between West 54th and West 55th Streets), consisting of a basement used for an office and petitioner's*38 residence, a main (street level) floor used by Fergus Motors for displaying automobiles, and a second floor rented to a third party,

(b) 444 West 55th Street, New York City, a six-story building occupied by Fergus Motors, and

(c) 138-140 West 54th Street, New York City, consisting of a five-story garage rented to a third party.

In addition to its space in the buildings listed above, Fergus Motors occupied a branch showroom on Park Avenue.

During 1954 Fergus Motors employed, inter alia, the following key men: Guy M. Stanfill, service manager; Milton Gold, parts manager; and Louis Santelli, Park Avenue salesroom manager. Peter *15 Fritz Dube had also been employed as assistant to the petitioner from January 1952 to March 1953.

Sometime prior to September 1954, when petitioner was approximately 75 years old, he approached Stanfill, Gold, and Santelli and told them that he was considering closing up his automobile business. He said that he was losing money, that he was getting old and tired, and that he wanted to spend more time with the automotive inventions and experimental work which had occupied much of his spare time over the years. He indicated that he would like to *39 work out an arrangement with these key employees whereby, subject to certain conditions, they would buy or take over the operation of his automobile business. In September 1954, Gold told Dube, petitioner's former assistant who had left Fergus Motors in 1953, about petitioner's suggestion and invited Dube to join the others in the venture. Dube became the leader of the group which included Stanfill, Santelli, and Gold (hereinafter sometimes called the Dube group), and the group began negotiating with the petitioner for the acquisition of his business.

After over 6 months of give-and-take negotiations at which both sides were represented by counsel, on June 29, 1955, petitioner entered into an agreement (hereinafter referred to as the 1955 agreement) with the Dube group, pursuant to which the automobile business (all of the assets of Fergus Motors) and the stock in 444, the real estate corporation, were transferred to a newly organized New York corporation, Fergus Enterprises, Inc. (herein called Enterprises). Enterprises was to have a class A voting stock and a class B nonvoting stock, initial issuance of which were to be as follows:

*40 Joseph B. Ferguson, Jr., petitioner's son, was included in the transaction as a stockholder (and salaried employee) of Enterprises upon petitioner's insistence.

Prior to signing the 1955 agreement, an understanding was reached whereby petitioner would, at some time subsequent to the organization of Enterprises, transfer his 80 voting shares to the other five stockholders in exchange for the 80 nonvoting shares, so that ultimately the Dube group (and Ferguson, Jr.) would own all the voting stock. This exchange was subsequently effected by written *26 agreement dated February 9, 1956, after which petitioner owned all of the 8,000 outstanding nonvoting shares, and the other five stockholders owned all of the 95 outstanding voting shares. Though complete control was placed in the other five stockholders, petitioner's 8,000 nonvoting shares represented a 98.8-percent equity in the corporation, which he considered at least equal in value to the property he had transferred to Enterprises.

The 1955 agreement provided, inter alia, as follows (references in the quoted passages to "Ferguson" are to the petitioner, and references to "The undersigned" are to the Dube group and Joseph*41 Ferguson, Jr.):

4.a. Immediately upon organization of ENTERPRISES, FERGUSON shall be employed as consultant to the Corporation for the rest of his natural life and shall be in the head of and in full charge and control of the Experimental Division, which ENTERPRISES shall set up. FERGUSON shall receive such salary plus a bonus as may be determined by the Board of Directors, but in no event shall his salary or his bonus or any additional compensation be less than any of THE UNDERSIGNED, or of any officer of the proposed corporation.

* * * *

5.a. Immediately upon organization of ENTERPRISES, it shall set up an an Experimental Department, to be equipped with the machines and equipment now available which may be required by FERGUSON, which department shall occupy not less than one-fourth (1/4) of the space of the 6th floor of 444 West 55th Street, New York City, and provide the necessary heat, electricity, power and telephone service thereto. Said Experimental Department will be under the supervision and full and complete charge and control of FERGUSON. There shall also be set over to FERGUSON not less than one-third (1/3) of the basement space at 1717 Broadway, New York City in the*42 portion of said premises, now occupied by FERGUSON, which space shall encompass that now occupied by FERGUSON, and also phone extension thereto, all the above free of rental, cost, expense or other charge, and as a consideration of the sale.

b.1. ENTERPRISES shall pay monthly on or before the 10th day of each month for the month immediately preceding from the gross cash income of all sources whatever of ENTERPRISES such sums of money as shall be equal to three (3%) percent of said gross cash income of ENTERPRISES as stated above, exclusive of salaries, bonuses and additional compensation as otherwise provided for herein, which shall be paid directly by ENTERPRISES to FERGUSON. Said payments shall be made to and deposited in a special and separate bank account, which shall be called ENTERPRISES Experimental Account or any other similar name, the disbursement of the money therein shall be under FERGUSON'S sole authority and discretion, providing same be for the benefit of said Experimental Department. FERGUSON shall have the expressed right to designate the disbursing agent and signatory of said special account. * * *

c. The Fund so established shall be the total budget to said Experimental*43 Department from said ENTERPRISES. The liabilities shall not exceed the budget of the Experimental Department. FERGUSON shall be liable for any excess thereof. However, said Experimental Department shall be permitted to accept and take in and perform outside machine work, the proceeds of which shall be deposited in said special account and to be used by said Experimental *17 Department. A statement of all such monies earned shall be issued to ENTERPRISES by the said Experimental Department no later than the 10th day of the month for the month immediately preceding same. The Experimental Department shall have the right to utilize all such income in the operation of the Experimental Department. However, at the end of the fiscal or calendar year, whichever the case may be, should any taxes be required to be paid by ENTERPRISES due to said outside work, said taxes shall be paid by the said Experimental Department to ENTERPRISES for that purpose only.

d. The said Experimental Department may be terminated upon the death of FERGUSON and the provision of said paragraph shall cease and be no obligation on the part of ENTERPRISES to continue same beyond the natural life of FERGUSON*44 and all the assets of said Experimental Department shall revert back to ENTERPRISES.

6. The rights to any and all inventions, models, drawings, plans, data and all letters patent derived or obtained by reason of the aforementioned Experimental Department shall be the sole property of ENTERPRISES for the Western Hemisphere. The setting up and continuance of said experimental department is an express consideration and requirement herein, and any defense as to the enforceability or failure to show that any damage would result to FERGUSON upon discontinuance of this department is hereby waived by the undersigned. However, FERGUSON, during his lifetime, shall have all rights to said patents in all other places in the world, excepting as heretofore stated for the Western Hemisphere. Upon his death, all of the rights given to FERGUSON by reason of this Paragraph 6 or by reason of FERGUSON being the inventor shall pass to his heirs, beneficiaries or estate. In addition to the above, ENTERPRISES shall pay to the estate of FERGUSON or to his nominee or designee the sum of $ 4,000.00 per year in equal weekly installments during the lifetime of LUCILLE M. FERGUSON, FERGUSON's present wife.

*45 7a. That the stock of 444 WEST 55TH STREET CORPORATION shall be deposited in TRUST, with designated trustees to be appointed, for the faithful performance of ENTERPRISES of the terms, conditions and liabilities of this agreement and FERGUSON'S lifetime employment contract. ENTERPRISES shall have the right to vote said stock deposited in trust hereunder so long as ENTERPRISES is not in default of any of the terms of this agreement. * * * This trust unless sooner terminated shall terminate upon the death of FERGUSON and the stock deposited hereunder shall forthwith be returned to ENTERPRISES. * * *

b. No illness or disability of FERGUSON shall be a cause for the breach of this contract nor cause same to come to an end; nor shall the length of time during which FERGUSON may remain away from his work due to illness, or any other cause, be a cause for breach of [sic] termination of this contract. FERGUSON shall be the sole judge of his requirements for absences, or for his presence, or time required for the rendering of his services and performing his duties. During any happening of the above, the compensation of FERGUSON shall not cease, but be paid regularly. *46 ENTERPRISES specifically agrees to the above.

c. That neither ENTERPRISES or [sic] TRUSTEE of 444 WEST 55TH STREET CORPORATION shall have the power or right to sell, rent, lease, sublease, exchange mortgage or in any way dispose of the real properties of its appurtanences [sic] furniture, fixtures or equipment or machinery used with the real properties or for the repairs or automobile work, without the written consent of FERGUSON and both FERGUSON and THE UNDERSIGNED agree that the said shares of stock of 444 WEST 55TH STREET CORPORATION *18 shall be endorsed thereon to the effect that it is subject to the FERGUSON employment agreement. * * *

d. That ENTERPRISES shall have the use of the properties of 444 WEST 55TH STREET CORPORATION, so long as ENTERPRISES shall promptly pay all taxes of every nature whatsoever both of 444 WEST 55TH STREET CORPORATION and the properties, interest and mortgage installments, mortgage principal balance when due or the renewal of said mortgage with the consent of FERGUSON, as and for rental for the said properties * * *

The 1955 agreement*47 also expressly provided that Enterprises would have the right to organize one or more wholly owned subsidiaries, provided only that any such subsidiary would be found by all the provisions of the June 29, 1955, agreement. Pursuant to this authority, Enterprises formed Fergus Imported Cars, Inc. (herein sometimes called Imported), a New York corporation, as its operating subsidiary. For convenience, hereinafter references to Enterprises, where appropriate, shall encompass its wholly owned subsidiary, Imported.

Sometime subsequent to the execution of the 1955 agreement and the organization of Enterprises and Imported, a checking account was opened with a New York bank in name of "Fergus Imported Cars, Inc., Experimental Department." In order to open that account Imported adopted and furnished an appropriate bank account resolution and Dube, who had become president of Imported, personally went to the bank to open the account. Petitioner was the sole person authorized to sign checks on this account. For the period July 1, 1955, to February 25, 1957, Imported paid into the experimental department checking account $ 54,642.78 and also paid $ 11,173.61 directly to employees of said *48 experimental department.

After the transfer of petitioner's automobile dealership to Enterprises, provision was made by Enterprises for petitioner to take over the entire third floor of the 55th Street building (owned by 444) for operation of the so-called experimental department. A considerable amount of machinery was placed in petitioner's third-floor shop pursuant to the 1955 agreement, including lathes, milling machines, and shaping machines, as well as tools commonly used in automobile repair shops. Approximately one-quarter of the floor was used for office space and a substantial portion was used for storage of cars.

The experimental work carried on by petitioner in his spare time prior to the conveyance of his automobile dealership to Enterprises in 1955 was thereafter carried on by him in his third-floor shop known as the experimental department. ¹ Petitioner has always viewed his *19 experimental work as a serious endeavor and not as a hobby. The experimental work in which petitioner was engaged during the tax year in question related to a new type of engine which he believed would be far more efficient than conventional engines, and to the use of compressed air *49 to help run the engine, brake the car, and operate accessories. Petitioner is confident that his device will ultimately be salable, that demand will be great and that proceeds from sale of rights in the invention will run into millions. Petitioner has not applied for any patents in connection with these experiments. In addition to the experimental work carried on subsequent to the 1955 agreement, petitioner engaged the experimental department in certain profit-making transactions described hereinafter.

On the other hand, the members of the Dube group generally did not take petitioner's experiments seriously. *50 They viewed his work as a kind of devoted tinkering by a man who in his younger days had been materially involved with the early history of automotives. They were aware that he had once developed his own automobile and that he once held several United States and British patents, but because of his advanced age at the time of the 1955 agreement and because he apparently had not secured any patents or commercially exploited any results of his part-time experimental work during the time they were associated with him (as employees of Fergus Motors), they placed virtually no value upon his experimental work. Although, under the 1955 agreement, Enterprises was to have exclusive rights in the Western Hemisphere to the exploitation of any inventions developed in the so-called experimental department, the Dube group, generally, never expected that any exploitable inventions would be developed. The entire experimental department arrangement was suggested by petitioner, and the Dube group regarded the so-called department as in substance under the control and ownership of petitioner. The required 3-percent (of gross sales) payments to be made by Enterprises to the experimental department*51 under the 1955 agreement were regarded by the Dube group as in substance rental payments to petitioner for the use of the buildings in which Enterprises carried on its business.

Despite the fact that he received annual payments designated as salary pursuant to the terms of the 1955 agreement, petitioner did not perform any services for Enterprises during the years 1955 through 1959, inclusive, except insofar as his experimental work could be considered as benefiting Enterprises.

Between September 1956, and February 1957, several lawsuits were instituted in the Supreme Court of the State of New York relating to the 1955 agreement between petitioner and the Dube group. In *20 September 1956, petitioner's wife, from whom he was then judicially separated, instituted an action against petitioner, joining as defendants, inter alia, Enterprises, Imported, 444, and the Dube group. Her action was to set aside the June 29, 1955, agreement and the transactions pursuant thereto on the grounds that petitioner engineered same for the purpose of concealing his interest in his properties in order to defeat her claims for alimony arrearages and that he remained beneficial owner of all the*52 property that he purportedly transferred pursuant to said agreement.

The second lawsuit was a stockholders' derivative action instituted in December 1956, by petitioner against the Dube group and Joseph Ferguson, Jr., and naming Enterprises and Imported as parties defendant. This action charged the Dube group with waste of the corporate assets of Enterprises as a result of their action in increasing salaries (including petitioner's), allegedly in violation of the 1955 agreement. The Dube group retained counsel to defend this action, and counsel recommended as a defensive measure a suit against petitioner for an accounting of the experimental department funds pursuant to the language of the 1955 agreement. Thus, in February 1957, Enterprises and Imported as joint plaintiffs brought suit against petitioner as manager and director of the "Experimental Department," charging him with breach of trust and dissipation of trust funds, to wit, the moneys paid by Imported into the "Experimental Department."

These three actions were adversary proceedings and were vigorously contested by all of the parties. They were tried for 5 days in a New York court. The trial judge died before rendering*53 a decision, and a retrial was held. The Dube group was very anxious to settle the triangular litigation; they viewed themselves as having been caught in the middle of what was essentially a dispute between petitioner and his estranged wife. After the retrial the parties negotiated for another 3 weeks or so until, on May 23, 1958, a written stipulation was executed in settlement of all the lawsuits. Said stipulation of settlement was incorporated into an order and judgment of the New York court.

The relationships between petitioner, Enterprises, Imported, 444, the Dube group, and the so-called experimental department were substantially changed under the May 23, 1958, settlement agreement (hereinafter referred to as the 1958 agreement) from what they had been under the 1955 agreement. The pertinent provisions of the 1958 agreement may be summarized as follows:

1. The stock in 444 was to be released from trust and delivered free and clear to petitioner.

*21 2. Imported was to lease from 444, for a 5-year term commencing July 1, 1958, the main floor and basement at 1717 Broadway and the entire building (except the third floor) at 444 West 55th Street.

3. The 7,500 shares of Enterprises*54 class B nonvoting stock under the control of petitioner were to be surrendered back to the company. ² The 10 shares of class A voting stock held by Joseph Ferguson, Jr., were to be surrendered to the company for $ 1,250.

4. The 1955 agreement was expressly canceled.

5. The employment agreements entered into with petitioner and Joseph Ferguson, Jr., pursuant to the 1955 agreement were canceled. A new arrangement provided that petitioner would receive from Imported $ 5,200 per year for life as a consultant.

6. The rights and obligations as between petitioner and his wife were settled in a separate agreement executed contemporaneously with the instant one.

7. In the event that Imported*55 should vacate the two buildings of 444 which it occupied, it would forfeit its right to use the name "Fergus."

8. Petitioner agreed to hold harmless, Imported, Enterprises, and the Dube group from any Federal income tax claims which might arise against them based upon "transactions entered into, business done and income derived by" Fergus Motors and/or petitioner subsequent to the date of the 1955 agreement.

9. The "experimental fund" was to be continued under the sole management and direction of petitioner, all parties acknowledging that the terms of the 1955 agreement with respect to said fund had properly been complied with by both Enterprises (and Imported) and petitioner. Future expenditures from the experimental fund, as in the past were to be on the sole signature of petitioner "in such amounts and for such purposes as in his judgment may be necessary to further the purpose of experimentation."

10. Payments by Imported into the experimental fund were to be according to the following schedule:

Each applicable percentage was to be reduced by *56 1/2 percent in the event of petitioner's death prior to June 30, 1963. A minimum annual payment of $ 75,000 (at $ 6,250 per month) was provided; i.e., in no *22 year could the payments arrived at by the percentage formula be less than $ 75,000. Said $ 75,000 was to be "deemed received by and in payment and satisfaction of the rents required to be paid under and pursuant to the aforementioned agreements of lease." (Par. 2 above.) In the event of sale of either of the buildings to be leased or of the stock of 444, then Imported's obligation to the experimental fund as provided above would be reduced by the amount of rent paid to the new owner.

11. The experimental fund was to be discontinued after June 30, 1963, the end of the 5-year term during which 444 was to lease the two buildings to Imported.

12. Petitioner, "as manager and director of the Experimental Fund and bank account" was to make available all books and records of the experimental fund "required for tax purposes by Imported."

13. Petitioner was in no event permitted to use experimental fund money to compete with the businesses of Enterprises or Imported.

14. Petitioner and 444 agreed to hold Enterprises and Imported*57 harmless from any liabilities or obligations arising from the operation of the experimental fund.

The following highly pertinent paragraphs are quoted verbatim from the 1958 agreement:

H. Whenever the Experimental Fund is terminated, whether by lapse of time or by direction of Joseph B. Ferguson, Sr., or his heirs, executors or administrators, as the case may be, all existing assets of the Experimental Fund or future assets acquired through the use of Experimental Fund monies shall be immediately and forthwith transferred to Joseph B. Ferguson, Sr. and/or his heirs, executors or administrators, as the case may be. Notwithstanding, in such case, Imported shall continue to own and receive 20% of the proceeds of any and all patent rights developed by said Experimental Fund for the period of five years in the State of New York.

* * * *

J. Federal or state income taxes, if any, which may be due or owing with respect to moneys heretofore paid, or which may hereafter be paid into the Experimental Fund, shall be the debts and obligations of Imported and/or Enterprises, and not of Joseph B. Ferguson, Sr., or the said Experimental Fund, provided, however, that regardless of whether in any *58 one year the percentage amounts provided for in paragraph 13B shall yield $ 75,000 or more or less, than 1) the amount of $ 75,000 therein contained shall be deemed and regarded by the parties, and is, an item of expense of Imported and/or Enterprises, to wit, the rent provided to be paid under the said agreements of lease for that period of time, and 2) the liability of Imported and/or Enterprises for federal and state income taxes, based on the excess paid into the Experimental Fund over the $ 75,000 aforementioned, shall not exceed 65% of the taxes based upon such excess, and Joseph B. Ferguson, Sr. agrees to indemnify, save and hold harmless Imported and/or Enterprises from tax liability as to the remaining 35% based on such excess.

*23 The unusual nature of the 1958 settlement agreement resulted from a negotiated compromise designed to satisfy a diversity of interests. Petitioner's wife insisted that the valuable real estate be returned to petitioner's ownership and control and that it be leased to Enterprises and Imported for fixed specified rent which she could look to for satisfaction of her alimony claims. Petitioner, on the other hand, wanted to retain the form of *59 the 1955 agreement under which 3 percent of Imported's sales was paid into the so-called experimental department. The Dube group was willing to pay $ 75,000 to $ 85,000 a year for rental of the space which Imported occupied in the buildings at 444 West 55th and 1717 Broadway, and they estimated that 3 percent of their sales for the first year under the new agreement would approximate that amount. However, they anticipated annual increases in sales, and thus were unwilling to accept a lease arrangement based upon a fixed percent of sales. Both the petitioner's wife and the trial court judge, who participated in the settlement negotiations, insisted for the wife's protection that the payments by Imported for occupancy of the buildings be clearly labeled as rent. The net result, as detailed above, was an agreement providing for annual payments by Imported of at least $ 75,000 labeled as rent, and further providing for payments into the experimental fund of a percentage of annual sales, to the extent such percentage exceeded $ 75,000. The percentage was to decline by one-half percent each year to allow for expected annual increases in sales and thereby maintain*60 the result of the percentage computation at approximately $ 75,000.

In 1959, there occurred a boom in the imported car business, and as a result, a substantial increase in sales was experienced by Imported. This meant that the percentage payments required to be made by Imported under the 1958 agreement came to far more than the approximately $ 75,000 anticipated by the Dube group. Such payments totaled $ 132,592.57, and they were made as follows: Twelve monthly checks for $ 6,250 were drawn and delivered to 444. These checks were labeled "rent" and together totaled $ 75,000. They were all deposited in a checking account maintained in a New York bank in the name of 444 West 55th Street Corp. An additional $ 57,592.57 was paid by checks made payable to "Fergus Imported Cars, Inc.-Experimental Department," which checks were deposited in a checking account bearing that same designation. Both of the above-mentioned checking accounts were maintained in the same New York bank, and petitioner was the only person authorized to sign checks on either account.

Also, during 1959, a savings account in the name of "Joseph B. Ferguson (Fergus Experimental)" was maintained in the West Side Federal*61 Savings & Loan Association. Petitioner was the only person *24 authorized to sign withdrawal slips to withdraw funds from that account. During 1959, interest income aggregating $ 1,185 was credited to this account, none of which was reported by petitioner in his personal tax return.

The $ 75,000 paid by Imported to 444 in 1959 specifically as rent was considered by petitioner to be experimental department property, and it was expended by him for what he considered experimental fund purposes, including loans to and investments in various automobile dealerships and other ventures with third parties. Petitioner's wholly owned corporation, 444, in its Federal income tax return for 1959 made the same claim; it excluded the $ 75,000 from income with the explanation that the receipts "are applied to Experimental Department of Fergus Imported Cars, Inc."

During 1959, as he had done since 1955, petitioner carried on his experimental activities in his third-floor shop at 444 West 55th Street. In addition to his experimental work petitioner bought, sold, and repaired used cars, primarily foreign models. Occasionally, he would purchase a car with unusual characteristics, use it in his*62 experimental work, and then sell it, frequently at a net profit. He advertised cars for sale or rent in the newspaper. A considerable portion of his total space on the third floor was used for storage of automobiles. Petitioner had several employees. These men, when they were not engaged in experimental work, performed automobile repairs.

The so-called experimental department did not file any income tax returns. Petitioner never reported the results of the investment or business activities of the experimental department to Imported or the Dube group, and neither the Dube group nor Imported ever requested an accounting from petitioner under the 1958 agreement. Petitioner maintained practically no books and records related to experimental department activities and the few that were kept were totally inadequate for purposes of disclosing taxable income.

Petitioner's personal income tax return for 1959 reported as the sole income item a salary of $ 7,280. Although the return listed Imported as his employer, said "salary" was not paid to petitioner by Imported, but rather, petitioner paid it to himself out of the experimental department bank account.

444 did not report in its 1959*63 return the $ 75,000 paid to it by Imported pursuant to the 1959 agreement and lease, nor did it report the $ 57,592.57 paid by Imported directly to the so-called experimental department. Neither did it report interest income of $ 1,654.35 credited to its savings account at the West Side Savings & Loan Association during 1959. On the other hand, depreciation totaling $ 8,380 relating to the two buildings leased to Imported was included in expenses deducted in the same return.

*25 On December 19, 1963, a notice of deficiency was mailed to 444 asserting a deficiency for 1959 in the amount of $ 35,529.21, the principal adjustment therein being a determination that 444 understated its 1959 rental income by $ 75,000. On June 12, 1964, a second notice of deficiency was issued to 444 for the year 1959, increasing the unreported rental income from $ 75,000 to $ 132,592.57.

Imported and Enterprises were liquidated sometime shortly after April 30, 1962. On May 3, 1962, Imported and the Dube group, as parties of the first part, entered into an agreement with 444, petitioner and "the Experimental Division of Fergus Imported Cars, Inc.," as parties of the second part, wherein the business*64 of Imported was sold to petitioner, and the parties released each other from all obligations under the 1958 agreement. The "Experimental Division," however, was to, and did, continue in existence as in the past, and at the time of trial it was being operated by petitioner under a percentage-of-sales arrangement similar to that in effect during 1959, but with a new corporation organized by petitioner's son and others.

ULTIMATE FINDINGS OF FACT

The so-called experimental department was at all times relevant the personal property of petitioner.

During the year 1959, 444 West 55th Street Corp. was on the cash method of accounting.

OPINION

In the course of preparing for their defense in this Court of a deficiency of less than $ 1,200 resulting from disallowance of an alimony deduction, respondent's attorneys found themselves swept along on a voyage of discovery which in its own way came to rival Carter's exploration of the tomb of Tutankhamen; the wonders and tax treasures ultimately unearthed from beneath an unobtrusive surface were so great that respondent has now conceded the original alimony adjustment which prompted his voyage and has amended his pleadings to allege new deficiences*65 totaling in excess of $ 300,000. Petitioner, whose tax return showed a modest salary as his only income, was discovered to h