dissenting: With due deference, I dissent.
Code section 1232(a)(1) provides that amounts received by the “holder” on the retirement of evidences of indebtedness, including notes, “shall be considered as amounts received in exchange therefor” if such evidences of indebtedness are “capital assets in the hands of the taxpayer.” As a result of the June 15, 1962, transaction between petitioners and Ovid Birmingham, petitioners became holders of the Birmingham Steel notes which, the majority concedes, were evidence of bona fide debts in Ovid’s hands. Such notes were capital assets in the hands of petitioners. Accordingly, as I view this case, section 1232(a) (1) compels the conclusion that payments of the notes shall be “considered as amounts received in exchange therefor.”
The majority opinion holds that the notes payable to Ovid Birmingham when assigned to petitioners became equity despite what I believe to be petitioners’ intent to the contrary. Further, the majority arrives at its conclusion that the notes became equity in the hands of petitioners despite the fact that the notes were valid debts in the hands of Ovid Birmingham; despite the fact that the notes would have been valid debts in the hands of third parties or if retained by Ovid Birmingham; despite the fact that Birmingham Steel had no need for additional capital; despite the fact that respondent concedes the sale was a bona fide, arms-length transaction; and, I assume, despite the fact that the notes would have been evidence of bona fide indebtedness in the hands of a third party if petitioners had transferred, rather than collected, the notes following the June 15, 1962, transaction.
One may wonder what it is that gave these pieces of paper the chameleonlike ability to change character as they traveled from hand to hand. The majority says they were equity because they were “in the fullest sense ‘at risk,’ ” but they were equally at risk in anyone’s hand. Obviously, this is not the source of the transforming power.
Were the notes equity in petitioners’ hands because Birmingham Steel needed additional capital? Of course, the corporation’s capital needs did not change as the notes traveled from hand to hand. And, there is no evidence the corporation needed additional capital.
This was not a new corporation. It was organized on April 28,1949. The early years of its financial history are not shown, but it had net income of $22,111.20 in 1956 and $47,339.19 in 1957. From 1959 through 1962 it engaged in a steel supply business in addition to doing steel fabricating, and it incurred losses for each of those years as described in the findings. These losses were incurred mainly in the steel supply portion of the business which the corporation was phasing out in 1962. The losses had necessitated additional funds for operating expense which Ovid Birmingham supplied through the loans here in dispute.
The majority emphasizes that Birmingham Steel’s books showed a substantial deficit on June 15, 1962, and apparently from this fact infers the notes 'became equity — the so-called thin-capitalization theory. But “real values rather than artificial and book values should be applied” in the determination of debt-equity ratios. Kraft Foods Co. v. Commissioner, 232 F.2d 118, 127 (C.A. 2, 1956). On June 15, 1962, Birmingham Steel had a going steel fabrication business with strong earning potential, demonstrated by its net income of $47,339.19 in 1957; its overall net sales were $688,035.11 in 1960 and $1,039,471.90 in 1961; it had a well-equipped, assembled plant already in production ; it had a 'lease on strategically located property renewable for 25 years. These assets which existed as of the time of acquisition were not shown on corporate financial statements. I am convinced that the going-concern value of the steel-fabricating portion of the business was substantial. See Ainslee Perrault, 25 T.C. 439, 450-451 (1955), affirmed per curiam 244 F. 2d 408 (C.A. 10, 1957).
All the corporation needed to regain its former profit-making status was the cessation of the steel supply business and the infusion of new management. It is apparent from his attitude shown as a witness as well as the record as a whole that Ovid Birmingham, heir of the late, wealthy, Thomas Frank Birmingham, lacked the interest, desire, or ability to make the 'business really succeed. Petitioners, on the other hand, 'had started a similar business in 1958 which grew from gross sales of $72,000 in that year to $1,266,212.85 in 1962.
Under petitioners’ aggressive management Birmingham Steel quickly recouped its losses without the infusion of any new capital. It liquidated the inventory of the steel supply portion of the business, thus acquiring cash needed for the operation of its steel-fabricating business and for debt payment. As of December 31, 1962, its balance sheet shows no indebtedness except accounts payable of $11,911.13, a small amount of accrued taxes, and the balance of $220,000 due on the notes here in dispute. Its net income was $14,490.08 in 1962, $82,486.74 in 1963, and $191,109.63 in 1964. Disler Engineering’s income, as disclosed by the findings, also increased during this period; therefore, there is no basis for an inference that Disler Engineering’s income was channeled to Birmingham Steel.
It is well established that every debt-equity case turns on its own facts, John, Kelly Co. v. Commissioner, 326 U.S. 521 (1946), and the facts in Jewell Ridge Coal Corporation v. Commissioner, 318 F. 2d 695 (C.A. 4, 1963), on which the majority opinion relies, are wholly distinguishable from those in the instant case. Jewell Ridge did not involve section 1232(a) (1) at all; it involved an attempted charge-off in 1953 of an allegedly worthless bad debt which the court found was not a debt but was equity. In 1942, three individuals had acquired the stock of a struggling railroad with a long history of deficits which continued through 1946 when — having been kept alive by the stockholders’ loans — the railroad’s indebtedness stood at $127,322.10. They had applied to Interstate Commerce Commission for permission to liquidate the assets of the railroad and permission had been granted. At this point Jewell Nidge paid $150,000 for (a) 6,000 acres of coal land, (b) the railroad’s notes to the creditor-stockholders, and (c) the stock of the railroad. Jewell Ridge set about trying to revive the railroad, advancing over $250,000 in cash from 1946 to 1953, bringing the total “debt” to over $384,000 when application was again made to the Interstate Commerce Commission to scrap the railroad because it could not support itself. In 1953, Jewell Ridge sought to charge off $231,666.60 as worthless bad débts.
Pointing to the fact that historically the railroad was a losing proposition ; to Jewell Ridge’s efforts to restore a failing enterprise; to the failure by Jewell Ridge to accrue interest on the purported indebtedness on its books or the railroad’s books (and this with Interstate Commerce Commission approval); to the fact that the advances were made even though the railroad had no immediate ability to repay; and to other factors, the court concluded that, even if the $127,322.10 represented loans when made by the prior individual owners, such indebtedness was contributed to the railroad’s capital by Jewell Ridge. The facts presented a typical debt-equity, thin-capitalization problem, decided on its own facts. The opinion has repeatedly been cited in similar debt-equity cases, primarily for the proposition that the issue in such cases is a factual one. See Universal Tractor Equipment Corp. v. United States, 269 F. Supp. 801 (E.D. Va. 1967); Wood Preserving Corp. v. United States, 347 F. 2d 117 (C.A. 4, 1965).
The facts in the instant case are vastly different. Here, Birmingham Steel had a history of successful operation of a potentially highly profitable business which, as late as 1957, had produced over $47,000 in net income, more than one-fifth of the total debt in question; in the preceding year it had sales in excess of $1 million; its losses in the years 1958 to 1961 were attributable to the steel supply business which was being phased out in 1962; it had no need for further capital; and, under new aggressive management with the steel supply venture liquidated, it had sufficient potential earning and debt-paying capacity to discharge the debts in dispute.
Were the notes equity in petitioners’ hands because they intended to make a capital contribution? There is no direct evidence to show an intent to contribute the notes to capital, and the testimony and documentary evidence are to the contrary. All parties to the transaction treated the notes as debt instruments, and, of course, they were handled in this manner on their tax returns. There is no basis for a contrary inference. Indeed, there is the express finding that “Petitioners understood that they were purchasing the stock for $5,000 and the notes for $70,000 and that the notes remained outstanding obligations of Birmingham Steel.”
Were the notes equity because they were simply a means, without “independent significance,” of purchasing the assets of Birmingham Steel? Once again the evidence does not support this conclusion. Petitioners first learned of Ovid’s interest in selling his business on June 12, 1962, and on that day inspected the plant. At the close of the inspection Edwards suggested that the plant and equipment were worth about $75,000. He could not have attached “independent significance” to the notes on that visit for two reasons: First, the finding is that, “at that time, Edwards knew nothing about the financial condition of Birmingham Steel.” Second, Edwards testified that on this visit he looked only at the machinery (not the books) because “this was what I thought was for sale.”
Two days later, on June 14, 1962, the date “letters of intent” were signed, another meeting was held. At this meeting negotiations shifted to a purchase and sale of the stock. Petitioners for the first time saw an abbreviated financial statement which did not mention the Ovid Birmingham notes and a Dun & Bradstreet report which did mention them. Robert Bridges, petitioners’ accountant, found that the books reflected the notes. Before petitioners would sign the letters of intent previously prepared by Kenneth Stainer, Ovid Birmingham’s lawyer, they insisted on amending the letters to call for a transfer of the notes as well as the stock. The contract of sale later prepared by Stainer and signed by tire parties expressly transferred the notes to petitioners at a stated consideration of $70,000. The corporation owed Tulsa Bank a $90,000 note guaranteed by Ovid Birmingham. Ovid paid this note and a corporate note payable to him was substituted and assigned to petitioners. The notes were subsequently shown as debts of the corporation on its financial statements and, finally, were paid in full. What else could petitioners have done to give the notes “independent significance” ?
Were the notes equity because petitioners intended to purchase only the assets of Birmingham Steel? Citing Kimbell-Diamond Milling Co., 14 T.C. 74 (1950), affirmed per curian 187 F. 2d 718 (C.A. 5, 1951), the majority opinion concludes that the assignment of the notes in no way altered petitioners’ “constant and single minded objective- — ■ i.e., to acquire the physical assets of Birmingham Steel through purchase of the outstanding equity interest. To hold otherwise would be to exalt form over substance.” The facts simply do not bear out this conclusion.
True, at the J une 12 meeting, petitioners thought only the machinery was for sale and expressed an opinion that it was worth $75,000. If a sale on that basis had been made, Ovid Birmingham would have had the task of disbanding the going business, liquidating the steel supply inventory, applying the proceeds to the payment of debts including some $95,899.18 owed to third parties as well as the note of $241,000 owed to himself, and collecting some $37,727.75 in accounts receivable. But between the June 12 meeting and the June 14 signing of the letters of intent, the negotiations shifted to a sale of stock — a proposal with vastly different implications. Not only did it saddle petitioners, through the corporation, with the responsibility of paying the debts of $95,000 to third parties, and liquidating the steel supply inventory, but also it gave them the notes of $241,000 and the stock of a corporation which owned a going business having sales in excess of $1 million in the prior year, with a well-equipped, assembled plant, and with a lease renewable for 25 years covering strategically located property. There is not a shred of evidence to support a conclusion that, once the negotiations shifted to a stock sale, petitioners had any desire, plan, or objective to acquire the physical assets of Birmingham Steel and the majority opinion points to none. And the fact is that the corporation was not liquidated but continued to exist and became a viable, prosperous enterprise. The mere happenstance that the opinion expressed by petitioners as to the value of the machinery turned out to be the same as the purchase price for the stock and notes should not affect the character of the transaction.
By “canceling” the Ovid Birmingham notes the majority opinion here decrees that Birmingham Steel, despite its proven income-producing and debt-paying capacity, shall assume, beginning at the end of 1962, the role of a corporation virtually without debt. The majority here decrees that petitioners, despite their intention and understanding to the contrary, shall be denied the right to occupy the dual relationship of stockholders and creditors. See Farley Realty Corp. v. Commissioner, 279 F. 2d 701 (C.A. 2, 1960). In my view, the majority opinion fails to heed the teaching of a host of decisions holding that stockholders of corporations have discretion in deciding 'how much of their investment they care to risk in the form of capital and 'how much they wish to risk in the form of debts. See, e.g., J. S. Biritz Construction Co. v. Commissioner, 387 F. 2d 451 (C.A. 8, 1967); Murphy Logging Co. v. United States, 378 F. 2d 222 (C.A. 9, 1967); Nassau Lens Co. v. Commissioner, 308 F. 2d 39 (C.A. 2, 1962); Byerlite Corp. v. Williams, 286 F. 2d 285 (C.A. 6, 1960); Miller's Estate v. Commissioner, 239 F. 2d 729 (C.A. 9, 1956); Kraft Foods Co. v. Commissioner, supra; Rowan v. United States, 219 F. 2d 51 (C.A. 5, 1955); Wilshire & Western Sandwiches, Inc. v. Commissioner, 175 F. 2d 718 (C.A. 9, 1949). Indeed, this case is stronger than tbe cited cases, as petitioners here, in an admittedly bona fide transaction, merely took the corporate financial structure as they found it.
I understand the majority’s reluctance to apply section 1232(a) (1) in a situation where a corporate note has been acquired at a large discount by a shareholder of the corporation, whether in the same transaction as the stock was acquired or in a subsequent one. It gives the appearance of siphoning dividend income from the corporation as capital gain. Congress has imposed limitations in the section as to original issue discount, section 1232 (a) (2), but has not seen fit to deny the benefits of the section to persons who occupy the dual role of stockholder and creditor.
Perhaps Congress has taken into account the fact that in a case like this one no new tax benefit is created by applying section 1232(a) (1). Ovid could have collected the principal of the notes without tax consequences. Under the June 15, 1962, transaction he sustained a capital loss measured by his basis of $241,000 minus the $70,000 which he received. This capital loss would correspond with petitioners’ capital gain under section 1232(a) (1). But the majority opinion upsets this symmetry by treating all of petitioners’ collections on the notes as dividends. I do not think this Court should undertake to make exceptions to section 1232(a) (1) without statutory direction.
FORRESTER, Fat, Dawson, and IrwiN, J Jagree with this dissenting opinion.