*2046 Where a stockholder in a corporation transfers part of his common stock and all of his preferred stock to an outside party in order to induce the recipient of the stock to assume management of the corporation and liquidate certain outstanding obligations of the corporation, and the preferred stock is subsequently turned in by the recipient and canceled, held that the taxpayer is entitled to deduct from gross income for 1923 the cost of the common stock and preferred stock transferred, less the proportionate benefit to taxpayer's common stock retained resulting from the cancellation and retirement of the preferred stock. (Following George M. Wright,18 B.T.A. 471">18 B.T.A. 471, and Edith Scoville,18 B.T.A. 261">18 B.T.A. 261.)
*742 In this proceeding the petitioner, Helene Baldwin Burdick, who is the executrix of Julian Burdick, deceased, seeks a redetermination of the decedent's income-tax liability for the calendar year 1923, for which year the respondent has determined*2047 a deficiency in the amount of $11,110.20.
The petitioner alleges that the respondent erred in failing to allow as a deduction from gross income for the taxable year 1923 the loss sustained by the taxpayer in the disposal of 1,041 shares of the capital stock of the Marf Machine & Die Casting Co., consisting of 600 shares of preferred stock and 441 shares of common stock. All the deficiency is based upon the disallowance of this alleged loss.
FINDINGS OF FACT.
The petitioner is the executrix of the estate of Julian Burdick, deceased, formerly of Breckenridge, Pa., who died April 21, 1929.
In May, 1920, the decedent purchased from the Marf Machine & Die Casting Co. all of its preferred stock, consisting of 600 shares of a par value of $60,000, and paid therefor $60,000 cash. At the same time he acquired 600 shares of the common stock from stockholders for $25,000 cash. Subsequently, decedent acquired 350 more shares of the common stock of said corporation, but there is no evidence to show what he paid for same and no loss is claimed in this proceeding because of the surrender of this 350 shares of common *743 stock. The total outstanding common stock was 1,900 shares*2048 with a par value of $100 each, or a total of $190,000. In the fall of 1922 the company was in serious financial difficulties. Its preferred stock was all owned by the decedent, and of the 1,900 shares of common outstanding he owned 950 shares; Arvid Jansson, 475 shares; and Frank Cohen, 475 shares. Joel W. Burdick, the father of the decedent, held the company's note for $36,328.60; the decedent, a secured note for $25,000; and Arvid Jansson, a note for $2,000. One Louis C. Kunz was induced to contribute $40,000 to the corporation in consideration of certain things embodied in an agreement between him and the stockholders of the corporation. This agreement was dated November 28, 1922, and by its terms the Guaranty Trust Co. of New York was designated trustee to make disposition of the stock and $40,000 contributed by Kunz. The terms of the agreement were fully set out in a letter to the Guaranty Trust Co., dated November 28, 1922, and signed by all the parties to the agreement. The text of the letter in words and figures is as follows:
In accordance with an agreement entered into between them, the undersigned will make delivery to you of the following securities, notes and*2049 cash, to be held by you in escrow and to be delivered and expended by you as hereinafter provided.
The undersigned, Julian Burdick, will deliver certificates of the common stock of the Marf Machine & Die Casting Company, Inc. aggregating 950 shares, certificates of the preferred stock of said company, aggregating 600 shares, and notes of said company payable to him, aggregating $25,000.
The undersigned, Arvid Jansson, will deliver to you certificates for common stock of the Marf Machine & Die Casting Company, Inc. aggregating 475 shares.
The undersigned, Frank M. Cohen, will deliver to you certificates for the common stock of the Marf Machine & Die Casting Company, Inc. aggregating 475 shares.
Louis C. Kunz will pay you the sum of $40,000.
On receipt of the aforesaid certificates of stock, aggregating 1,900 shares of common and 600 shares of preferred, and said sum of $40,000, you will kindly purchase at par and accrued interest, on behalf of Louis C. Kunz, the notes of the Marf Machine & Die Casting Company, Inc. to Joel W. Burdick aggregating $36,328.60 and the note of said company to Arvid Jansson, for $2,000, applying so much of the above mentioned sum of*2050 $40,000 as may be necessary therefor. The balance of said $40,000 is to be paid by you to said Julian Burdick on account of interest due on the aforesaid notes of the Marf Machine & Die Casting Company, aggregating $25,000 belonging to him.
After the purchase of the aforesaid notes from said Joel W. Burdick and Arvid Jansson, Julian Burdick authorizes and directs you to surrender to the said Marf Machine & Die Casting Company, Inc., the aforesaid notes aggregating $25,000, payable to him, upon receipt by you from said Marf Machine & Die Casting Company, Inc., of new unsecured notes of said Company, payable to said Julian Burdick, aggregating $25,000 plus any interest at that time that may be unpaid on the notes now held by him, said new notes to bear interest at the rate of 6% and to be payable as follows: $5,200 6 months after date of *744 delivery, $4,100 9 months after date of delivery, $5,200 12 months after date of delivery, $5,200 15 months after date of delivery, and balance 18 months after date of delivery.
After completion of the above transaction, you are hereby authorized and directed to distribute the 1900 shares of common stock, as aforesaid, as follows:
*2051 1425 shares to Louis C. Kunz, or his assigns.
159 shares to Julian Burdick, or his assigns.
158 shares to Arvid Jansson, or his assigns.
158 shares to Frank M. Cohen, or his assigns.
The new notes of the aforesaid Marf Machine & Die Casting Company, Inc., payable to Julian Burdick to be delivered to him; provided, however, that the aforesaid distribution and delivery shall not be made prior to January 4th, 1923.
You are hereby expressly authorized and directed, at the completion of the above, to mark the aforesaid notes of the Marf Machine & Die Casting Company, Inc., payable to Joel W. Burdick and Arvid Jansson, "Paid" and deliver the same to said company for cancellation.
The undersigned have agreed to use their best efforts to have the said Marf Machine & Die Casting Company, Inc., reduce its capital stock by the cancellation of the aforesaid 600 shares of preferred stock, or if that be impracticable, to convert said 600 shares of preferred stock into 600 shares of common stock. If the reduction is accomplished, you are authorized to deliver such certificates for 600 shares of preferred stock to said Company for cancellation. If the said preferred stock is*2052 converted into common stock, you are authorized and directed to exchange said 600 shares of preferred stock for 600 shares of common stock and distribute said common stock, as follows:
9/12 of said 600 shares to Louis C. Kunz, or his assigns
1/12 of said 600 shares to Julian Burdick, or his assigns
1/12 of said 600 shares to Arvid Jansson, or his assigns
1/12 of said 600 shares to Frank M. Cohen, or his assigns.
If the undersigned are unable to effect the reduction of capital stock of said Company, as aforesaid, or to have said 600 shares of preferred stock converted into common stock, then you are authorized and directed to distribute said 600 shares of preferred stock, as follows:
9/12 of said 600 shares to Louis C. Kunz, or his assigns
1/12 of said 600 shares to Julian Burdick, or his assigns
1/12 of said 600 shares to Arvid Jansson, or his assigns
1/12 of said 600 shares to Frank M. Cohen, or his assigns.
Direction by Julian Burdick and Louis C. Kunz shall be your authority as to which of the above alternatives is to be carried out.
Julian Burdick agrees to pay to you the sum of $150, as your commissions for carrying out the above.
It is understood and*2053 agreed that you have no responsibility as to the carrying out of the agreement mentioned in the first paragraph of this letter, but that your duty shall be limited to carrying out the directions contained herein.
The undersigned further agree that you shall incur no liability in carrying out the above instructions except for negligence.
On December 7, 1922, the stock and cash were delivered to the Guaranty Trust Co. and between January 18 and April 2, 1923, the Guaranty Trust Co. delivered the stock and used the cash in accordance *745 with the terms of the contract. The $40,000 delivered by Kunz to the Guaranty Trust Co. was used to pay the notes of Joel W. Burdick and Arvid Jansson and the balance, amounting to $985.16 was paid to Julian Burdick as interest on his note for $25,000.
The 600 shares of preferred stock which had on December 7, 1922, been delivered by Julian Burdick under the terms of the agreement to the Guaranty Trust Co. were delivered by it to Louis C. Kunz on April 2, 1923, and soon after he received it, Kunz had the Marf Machine & Die Casting Co. cancel and retire this stock, as was provided in the agreement.
On or about January 19, 1923, the*2054 following stock certificates, which the Guaranty Trust Co. had received from Julian Burdick, were returned to him:
No. C-42 for 1 share in the name of Joel W. Burdick
No. C-56 for 135 shares in the name of Julian Burdick
No. C-57 for 23 shares in the name of Julian Burdick
Total 159 shares
These 159 shares were subsequently sold by Burdick in 1927 for $50 per share, a total of $7,950.
The 159 shares of stock returned to Julian Burdick were part of the same certificates that had been included in the 950 shares of common stock transferred by him to the Guaranty Trust Co. Similar deliveries of 158 shares of common stock each were made to Arvid Jansson and Frank M. Cohen. These were a part of the same shares which they had originally turned over to the Guaranty Trust Co. under the terms of the escrow agreement.
On or about January 18, 1923, 1,425 shares of the common stock of the Marf Machine & Die Casting Co. were delivered to Louis C. Kunz. These were part of the same certificates for shares in the Marf Machine & Die Casting Co. which had been delivered to the Guaranty Trust Co. by Burdick, Jansson, and Cohen.
The decedent in his 1923 income-tax return claimed a*2055 loss of $78,372.06 as a result of the transaction, computed as follows:
| Cost: | |
| 600 shares of preferred stock $100 per share | $60,000.00 |
| 600 shares of common stock $41.66 per share | 25,000.00 |
| Total cost | 85,000.00 |
| Number of shares retained: | |
| 159 shares of common stock $41.66 per share | 6,623.94 |
| Total loss | 78,376.06 |
The respondent disallowed the loss, treating the transaction as a reorganization under the provisions of section 202(c)(2) of the *746 Revenue Act of 1921, and determined a deficiency in the amount of $11,110.20.
OPINION.
BLACK: The petitioner claims that Julian Burdick, decedent, sustained a loss in the year 1923 of $78,372.06 computed in the manner set out in our findings of fact. Petitioner bases his claim for the deduction under section 214(a)(5), Revenue Act of 1921. The Commissioner of Internal Revenue, respondent, refused to allow the loss, on the ground that the transaction was a reorganization or recapitalization of the Marf Machine & Die Casting Co., under section 202(c)(2) of the Revenue Act of 1921.
Section 202(c)(2) of that Act reads:
(c) For the purpose of this title, on an exchange of property, real, personal, or mixed, *2056 for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized.
* * *
(2) When in the reorganization of one or more corporations, a person receives in place of any stock or securities owned by him, stock or securities in a corporation a party to or resulting from such reorganization. The word "reorganization" as used in this paragraph, includes a merger or consolidation * * * recapitalization or mere change in identity, form or place of organization of a corporation (however effected).
Under the facts in evidence in this proceeding we hold that there was no reorganization of the Marf Machine & Die Casting Co. within the meaning of the section just quoted. The agreement in evidence in this proceeding shows a transaction between stockholders of the company and one Louis C. Kunz. The corporation was not a party to the transaction. The company continued to function after the transaction the same as before. The stock deposited under the terms of the agreement, to change hands, *2057 was not deposited with the corporation for the corporation. It was deposited with the Guaranty Trust Co. as trustee for the benefit of the parties signing the agreement and to be administered in accordance with the terms of the agreement. There was no change in the corporation's capital structure until after the transaction was completed. True, there was a redistribution of the 1,900 shares of common stock and 600 shares of preferred stock, deposited under the terms of the agreement. When the negotiations were completed and the Guaranty Trust Co. had carried out its terms, Julian Burdick was in possession of only 159 shares of common stock of the corporation, but it was not new stock. It was 159 shares of identically the same stock he had delivered in escrow to the Guaranty Trust Co. Louis C. Kunz was in possession of 1,425 shares of the common stock and 600 shares of preferred *747 stock, but it was not new stock. It was part of the same stock delivered in escrow to the Guaranty Trust Co. by Burdick, Jansson, and Cohen. It is also true that after the transactions were completed Kunz delivered to the corporation for cancellation 600 shares of stock which*2058 he had received from Julian Burdick, and it was canceled as provided in the original agreement. But even if this reduction of the capital stock of the Marf Machine & Die Casting Co. was a part of the same transaction by which Julian Burdick parted with 600 shares of preferred stock and 441 shares of common stock, there was no reorganization or recapitalization within the meaning of section 202(c)(2) in such transaction. When the 600 shares of preferred stock were delivered to the corporation by Louis C. Kunz to be canceled, the corporation gave no one anything in return. The stock was simply canceled, the capitalization of the corporation reduced, and the financial statement of the company improved. In order for this transaction to have come within the meaning of section 202(c)(2), the 600 shares of preferred stock delivered to the corporation would have had to be delivered in exchange for something.
The very language of paragraph (c) of that section begins by saying: "For the purpose of this title, on an exchange of property, real, personal, or mixed, for any other such property, no gain or loss shall be recognized, etc." It will be seen from the foregoing language that there*2059 must be some kind of an exchange before a transaction comes under the purview of section 202(c)(2).
Therefore we hold that the mere surrender to a corporation of certain shares of preferred stock to be canceled, with nothing to be received from the corporation in exchange therefore, is not a reorganization within the meaning of section 202(c)(2).
Of course, in making this statement we do not mean to hold that a recapitalization under a proper state of circumstances may not be a reorganization. For example, if corporation A has an outstanding capital stock of $100,000 represented by 1,000 shares of common stock of $100 par value per share, and decides to reduce its capital stock to $50,000, to be represented by 500 shares of common stock of a par value of $100 each, and provides that each stockholder shall receive in exchange one share for each two shares now held, we think that would undoubtedly be a reorganization because there would be the exchange contemplated by section 202(c)(2) and in such transaction no gain or loss would be recognized.
But if corporation A has an outstanding capital stock of $100,000, consisting of $50,000 common and $50,000 preferred, and decides*2060 to reduce its capital stock to $50,000 common by cancellation of all its preferred stock, but gives its stockholders nothing in exchange, and they agree to it, such transaction, we think, would not be a reorganization *748 within the meaning of section 202(c)(2). True, if this preferred stock is all owned by the stockholders in the same proportion to their holdings of common stock, there would be no actual loss to any stockholder, because the benefits resulting from the cancellation of the preferred stock would be equally distributed. .
The failure to allow a taxpayer a deductible loss under such circumstances does not result however from any provision of section 202(c)(2), but because of the fact that no actual loss has been sustained. In view of what we have said above, we hold that the transactions in this proceeding are those in which gain or loss may be recognized. Therefore the question to be decided is: What loss did Julian Burdick suffer in the transactions?
It seems to us that the facts in this case, in so far as the transfer of the shares of common stock is concerned, are very similar to those in *2061 . In that case a taxpayer had purchased stock in 1902. In 1922 the company was in financial difficulties and the bankers who had made loans to the company advised it that no further funds would be forthcoming unless the stockholders would surrender 51 per cent of their stock to the bankers. This was done and said stock which was surrendered was given to a new manager appointed by the bankers. The Board in that case held that the taxpayer sustained a loss of the cost to him of the shares of stock which he surrendered.
As has been stated, Julian Burdick was the owner of all the preferred stock of the corporation and if he had been the owner of all the common stock, there would have been no loss to him in his surrendering for cancellation the 600 shares of preferred stock owned by him. In that case we said: "The remaining stock absorbed the value inherent in the surrendered certificates and there was no more loss than there is a gain in a stock dividend. *2062 ; ."
But Julian Burdick was not the owner of all the common stock of the corporation. On the contrary, when the transaction was completed, evidenced by the agreement carried out by the Guaranty Trust Co., he was the owner of only 159 shares of the common stock of the corporation - the balance was owned by other stockholders. Therefore when the 600 shares of preferred stock were turned in to the corporation for cancellation some time in April, 1923, the exact date not shown, but after the common stock had been redistributed, the common stock which Burdick owned did not receive all the benefit of the cancellation. It received only its proportional share of the benefit. Since there were 1,900 shares of the common stock outstanding, the loss of Julian Burdick in the cancellation *749 of his 600 shares of preferred stock was the cost thereof, $60,000, diminished by 159/1900 of $60,000. Therefore, we think the deductible loss which should be allowed to petitioner on the whole transaction is $73,355.01 instead of $78,376.06 as claimed on the original return. Such result*2063 is arrived at as follows:
| Loss of petitioner: | ||
| Cost, 600 shares preferred stock, $100 per share | $60,000.00 | |
| Cost, 600 shares common stock, $41.66 per share | 25,000.00 | |
| Total cost | 85,000.00 | |
| Number of shares retained: | ||
| 159 shares common stock, $41.66 per share | $6,623.94 | |
| Proportional benefit to 159 shares common stock | ||
| retained by petitioner resulting from cancellation | ||
| of 600 shares preferred stock - | ||
| 159/1900 X $60,000 | 5,021.05 | |
| 11,644.99 | ||
| 73,355.01 |
Reviewed by the Board.
Decision will be entered under Rule 50.