*1426 Where, by a contract between a corporation and the stockholders of another corporation, the first corporation acquired all of the stock of the second, three fourths for cash and one fourth by exchange for a minority interest of its own stock, held, there was no reorganization within the meaning of section 112(i)(1) of the Revenue Act of 1928.
*1061 These proceedings were consolidated and involve the redetermination of the following deficiencies in income tax for the year 1928: A. L. Miller, $13,213.02; and Henry C. Hawk, $18,118.69.
*1062 Two of the errors asserted are common to both proceedings and are (1) that the respondent has failed to determine that no taxable gain arose from the exchange of shares of stock in the Enquirer-News Co. for shares of stock in Federated Publications, Inc.; and (2) if the petitioners are right in their first contention, then the respondent has erred in computing the amount of the taxable gain in that he has not applied the rule of first in, first out. In the proceeding*1427 by the Hawk estate it is further asserted that the respondent has erred in disallowing deductions for expense of maintaining and depreciation on an automobile.
FINDINGS OF FACT.
The petitioner, Ida W. Hawk, was appointed executrix of the estate of Henry C. Hawk by the Probate Court of Calhoun County, Michigan, on February 26, 1930.
The parties have stipulated the following facts:
1. The Enquirer-News Company, during all the times herein mentioned, was a newspaper publishing corporation of Battle Creek, Michigan, and had outstanding 800 shares of common voting stock, and no other stock of any class or character.
2. On August 15, 1928, A. L. Miller was the owner of 218 shares and Henry C. Hawk was the owner of 208 shares of common voting capital stock in the said Enquirer-News Company.
3. On August 15, 1928, A. L. Miller and Henry C. Hawk entered into three written agreements with Fenton, Davis & Boyle, a Michigan corporation, and Nichols, Terry & Company, an Illinois corporation (these two corporations are sometimes hereinafter referred to as "the bankers"), copies of which are attached hereto, marked Exhibits "A", "B", and "C", and by this reference made a part*1428 of this stipulation of facts.
4. Pursuant to the foregoing agreements, Federated Publications, Inc. was later organized and incorporated, by nominees of the bankers, under the laws of Delaware with an authorized capital stock of 10,000 shares of common stock without par value. Twelve shares were issued to nominees of the bankers for cash at the rate of $20.00 per share, but no other stock was issued until after the increase in capitalization hereinafter mentioned.
5. Pursuant to the foregoing agreements, the authorized capital stock of Federated Publications, Inc. was subsequently increased by charter amendment to 150,000 shares of common stock without par value and 52,000 shares of preferred stock without par value, the latter entitled to cumulative dividends at the rate of $2.00 per annum, and being subject to call and redemption at any time before the date of redemption into common stock on the basis of one share of preferred stock for one share of common stock and to have voting rights equally with the common stock if and when the dividends thereof were two years in arrears.
6. The said 52,000 shares of preferred stock were disposed of, 48,000 shares to Keane, Higbie*1429 & Company, bankers, for $25.00 per share in cash, and 4,000 shares to Russell J. Boyle, of Fenton, Davis & Boyle, for a valuable consideration.
*1063 7. The 150,000 shares of authorized common stock were reserved, issued and unissued, as follows:
| Issued on initial organization | 12 shares |
| Issued on subscription as per agreement hereinafter | |
| set out | 49,988 shares |
| Reserved for conversion of preferred stock | 52,000 shares |
| Reserved for stock purchase warrants (attached to de- | |
| bentures sold by the corporation) | 37,500 shares |
| Not issued | 10,500 shares |
| Total authorized | 150,000 shares |
8. A subscription agreement was executed by the taxpayers, a copy of the same being attached hereto, marked Exhibit "D", and by this reference made a part of this stipulation of facts.
A. L. Miller subscribed for 2,500 shares of common stock without par value, and Henry C. Hawk subscribed for 3,750 shares of such common stock.
While the subscription agreement set out above indicates that the capital stock of Federated Publications, Inc. was to be increased to 100,000 shares of common and 50,000 shares of preferred, the increase actually made was to 150,000 shares of*1430 common and 52,000 shares of preferred.
9. Of the cash received by Federated Publications, Inc. on subscriptions to its capital stock, $375,000.00 was used by it to pay for three-fourths (600 shares) of the stock in the Enquirer-News Company at $625.00 per share, A. L. Miller receiving $86,250.00 in cash for 138 shares and Henry C. Hawk receiving $55,000.00 in cash for 88 shares, and other owners of Enquirer-News stock receiving the remainder of such cash.
10. The remaining 80 shares of Enquirer-News stock owned by A. L. Miller were transferred by him to the new corporation in satisfaction of his subscription for 2,500 shares of common stock in the latter; and the new stock was issued and delivered to him by Federated Publications at that time. The remaining 120 shares of Enquirer-News stock owned by Henry C. Hawk were transferred by him to the new corporation in satisfaction of his subscription for 3,750 shares of common stock in the latter and the new stock was issued and delivered to him by Federated Publications at that time.
11. All the transactions described in paragraphs 4-10, inclusive, of this stipulation took place in the calendar year 1928.
12. A. L. Miller*1431 and Henry C. Hawk were the active managers of the Enquirer-News Company and continued in that capacity on behalf of the new owners, Henry C. Hawk until his death and A. L. Miller until the present time.
13. In accordance with paragraph 16 of the agreement, a copy of which is marked Exhibit "A" of this stipulation, the stockholders of the Enquirer-News Company withdrew assets and assumed liabilities as follows:
| Cash and securities withdrawn | $211,436.64 | |
| Less: Liabilities assumed | $31,931.12 | |
| Liabilities unpaid | 706.21 | |
| 31,224.91 | ||
| Net distributed | $180,211.73 |
The notice of deficiency in Docket No. 60689 finds that A. L. Miller's share in the distribution was $49,107.60, taxable as a dividend.
The notice of deficiency in Docket No. 60690 finds that Henry C. Hawk's share in the distribution was $46,855.05, taxable as a dividend.
*1064 14. A. L. Miller acquired his shares of Enquirer-News stock as follows:
| Date of Purchase | Number of | At date of | Cost Per | Total Cost |
| Shares | his disposi- | Share | Price | |
| tion repre- | ||||
| sented by | ||||
| Certificate | ||||
| No. | ||||
| February 14, 1919 | 16 | $100 | $1,600.00 | |
| 16 | 100 | 1,600.00 | ||
| 16 | 100 | 1,600.00 | ||
| 16 | 100 | 1,600.00 | ||
| 16 | 25 | 100 | 1,600.00 | |
| 16 | 100 | 1,600.00 | ||
| 96 | 9,600.00 | |||
| May 11, 1921 | 114 | 150 | 17,100.00 | |
| 210 | ||||
| December 28, 1923 | 8 | 29 | 275 | 2,200.00 |
| 218 | $28,900.00 |
*1432 15. Henry C. Hawk acquired his shares of Enquirer-News stock as follows:
| Date of Purchase | Number of | At date of | Cost Per | Total Cost |
| Shares | his disposi- | Share | Price | |
| tion repre- | ||||
| sented by | ||||
| Certificate | ||||
| No. | ||||
| February 28, 1919 | 16 | $145.50 | $2,328.00 | |
| April 29, 1921 | 160 | 26 | 150.00 | 24,000.00 |
| April 29, 1921 | 34 | 150.00 | 5,100.00 | |
| 210 | ||||
| December 24, 1923 | 8 | 28 | 275.00 | 2,200.00 |
| Total | 218 | $33,628.00 |
On January 25, 1926, Henry C. Hawk transferred and delivered ten shares of stock to his son, Henry C. Hawk, Jr., out of certificate No. 26, receiving therefor his son's promissory note for $3,000.00. Before the end of the year 1926, the note was cancelled by Henry C. Hawk and returned to the maker. No gain was reported for Federal income tax purposes on account of the disposition of said ten shares of stock, but the sum of $3,000.00 was applied by Mr. Hawk on his books to reduce the total cost of his stock holdings, so that on August 15, 1928, his books of account showed total holdings of 208 shares with a total cost of $30,628.00.
Exhibit A is a contract by which Miller and Hawk, after covenanting that they owned*1433 or controlled all the outstanding stock of the Enquirer-News Co., agreed to sell on or before December 1, 1928, to "the bankers" all the outstanding stock of the News Co. for the sum of $500,000. The purchasers were to deposit $5,000 with First Trust & Savings Bank as escrow agent within seven days, and the sellers were, within the same time, to deposit with the same agent the stock of the corporation. In the contract the sellers made certain representations and warranties and the contract provided that it *1065 could be terminated by either party on default by the other. Clauses 15 and 16 of the contract provide:
15. In the event that the organization, franchises, rights, powers, issuance of stock of said corporation and title to its property and assets are found to be legal and valid, and as herein represented, and its earnings and paid circulation are substantiated as herein set forth, and the other representations made by first parties herein are ascertained to be true and correct, and the agreements herein contained to be performed by them are fulfilled and they shall have deposited all of the outstanding capital stock of Enquirer-News Company as hereinabove provided*1434 with First Trust and Savings Bank, thereupon second parties shall make the further payment of Four Hundred Ninety-Five Thousand Dollars ($495,000) to First Trust and Savings Bank, at its office in Chicago, Illinois, on December 1, 1928, or on such day prior thereto as they shall have designated by not less than thirty (30) days' notice in writing delivered to first parties and to First Trust and Savings Bank at its office in Chicago, Illinois, and thereupon second parties shall be entitled to receive said stock as so deposited from said bank and said bank shall thereupon turn over the sum of Five Hundred Thousand Dollars ($500,000.) to or upon the order of first parties.
16. In the event that this agreement is consummated and carried out as in the section next preceding provided, it is understood and agreed that the cut-off date for settlement of the affairs of said corporation shall be taken as of the last day of the month preceding the final payment by second parties, as provided in the section next preceding, and that first parties may on or before the date of closing withdraw from said corporation all cash in bank accounts as of the cut-off date, and all surplus invested in*1435 securities, but shall not withdraw or assign any receivables not collected or any items or articles of inventory other than those mentioned herein as being subject to withdrawal, and first parties agree to assume and pay all bills and account payable by said corporation up to and including said cut-off date, including therein all income taxes payable by the corporation on income earned during the calendar year 1928, and corporation taxes due by the corporation and payable to the State of Michigan in 1928 and all state, county, city and local taxes assessed for or payable with respect to the year 1928. First parties shall also have the right to withdraw from said corporation, on or before the cut-off date, the three parcels of real estate and improvements situated thereon and attached thereto, a description of which is set forth on a paper attached hereto and marked Exhibit "A" and made a part hereof, provided that if second parties so elect, and specify in their notice fixing the time of closing, to acquire the parcel of real estate situated on a corner and marked "X" on Exhibit "A", they may do so by paying hereunder the additional sum of Twenty-five Thousand Dollars ($25,000) at*1436 the time of closing hereunder, and in that event said parcel of real estate and the improvements situated thereon shall not be withdrawn from the corporation.
Exhibit B is a contract between Miller and Hawk as parties of the first part and the same corporations as parties of the second part, in which the material provisions are:
WHEREAS, the parties hereto have contemporaneously with the execution of this Memorandum entered into an Agreement bearing even date herewith *1066 by the terms of which second parties are to acquire all of the outstanding capital stock of Enquirer-News Company, a Michigan corporation, and
WHEREAS, it is contemplated that second parties shall organize a corporation under the laws of the State of Delaware to be known as Federated Publications, Inc., and to acquire the outstanding stock of Enquirer-News Company, and
WHEREAS, first parties are to have by exchange an interest in said Delaware corporation.
Now, THEREFORE, in consideration of the premises, it is agreed that second parties or their assignee, Federated Publications, Inc., when organized, shall pay in cash for three-fourths (3/4ths) of the outstanding capital stock of Enquirer-News*1437 Company the sum of Three Hundred Seventy-five Thousand Dollars ($375,000) and shall exchange with first parties for one-Fourth (1/4) of said outstanding capital stock six thousand two hundred fifty (6250) shares of common stock of Federated Publications, Inc.
Exhibit C is a contract naming the escrow agent and fixing its authority and compensation.
Exhibit D is a subscription agreement which, after reciting the organization of Federated Publications, Inc., and the amount of its capital stock as then outstanding and thereafter to be authorized, provides:
Now, THEREFORE, the undersigned, hereby severally agree each with the other and with said corporation, in consideration of the mutual agreements herein centained, to take and pay for the number of shares of common stock without par value of Federated Publications, Inc., at the price of Twenty Dollars ($20.00) per share, as are subscribed for and set opposite their respective names, or any smaller number of shares which may be allotted to the undersigned.
IT IS FURTHER AGREED that upon the execution hereof each of the undersigned shall forthwith pay on his subscription the sum of Five Dollars ($5.00) for each share so subscribed, *1438 payable by check drawn to the order of the corporation, collectible at par in Chicago, to be sent to the corporation at Room 1545, 231 South LaSalle Street, Chicago, Illinois, and shall on December 1, 1928, or before upon five (5) days' written notice, pay the balance of his subscription or allotment in like manner and place.
IT IS FURTHER AGREED that Fifty Thousand Shares (50,000) of common stock shall be reserved for conversion of preferred stock and that for such part of fifty thousand (50,000) shares of common stock as are subscribed for hereby, voting trust certificates shall be issued, and the undersigned hereby constitute and appoint Herbert L. Nichols, or in case of his inability, incapacity or refusal to act, R. J. Boyle, their agent and attorney-in-fact to execute an agreement placing the common stock of said corporation in a voting trust, said agreement to be in such form and terms as shall be approved by said attorney, the undersigned hereby ratifying and confirming all that said attorney may do in the premises.
Immediately following the above provisions are spaces for signatures of subscribers. There are columns headed by the words: Name, Address, Date, Number of*1439 Shares, and Total Amount Payable. There are 43 subscribers, the first subscription being dated September *1067 24, 1928, and the last November 16, 1928. The subscriptions of Miller and Hawk are as follows:
| Name | Address | Date | Number of | Total Amount |
| Shares | Payable | |||
| 5. H. C. Hawk | B.C. | 9-24-28 | 2,500 | $50,000.00 Ex. |
| 6. A. L. Miller | B.C. | 9-24-28 | 2,500 | 50,000.00 Ex. |
| 43. H. C. Hawk | B.C. | 11-16-28 | 1,250 | 25,000,00 Ex. |
We find the following facts from the testimony introduced at the hearing. The symbol "Ex." was placed opposite the names of Miller and Hawk at their instance for the purpose of indicating that they were exchanging their shares in the old corporation for shares in the new, and to this extent were not purchasing. This was done for the purpose of carrying out the contract of August 15, 1928, designated as Exhibit B. It was not the intention of Miller and Hawk to retire from the newspaper business. Miller still retains intact his stock in the Federated Publications, Inc., and the estate of Hawk still retains the majority of his stock.
Hawk was a resident of Battle Creek, Michigan, and in 1928 was 62 years old. *1440 Prior to that year he had suffered a stroke of paralysis which rendered it impossible for him to attend to his business activities unless transported to them from his home, and then from one office to another. He was a man of varied interests. He owned stock in at least nine corporations in Battle Creek and vicinity. His total investments in these corporations amounted to over $407,000. He was president of three of these corporations, two of which were close corporations in which he took a very active part. He was vice president of one and vice president and treasurer of another, and was a director in seven of them. He also owned a farm and certain lots, both outside the city, in which he had invested the sums of $17,884.25 and $20,734.20, respectively. He actively attended to all of these affairs, using the automobile to transport him from one to another. The cost of this automobile was $5,345.98 and the depreciation on the car in the year 1928 amounted to $1,069.19. He employed a chauffeur to drive the car. He often had the chauffeur transact business for him when he was unable to go himself. The total expense of the car to him in 1928, including the chauffeur, was $3,044.50. *1441 Of both these amounts one half, or $2,056.84, was attributable to his business activities.
OPINION.
MARQUETTE: The petitioners assert that they are not taxable on the gain arising from the exchange of part of their stock in the News Co. for a part of the stock of Publications, Inc. They contend *1068 that there was a reorganization within the meaning of subsection (i)(1) of section 112 of the Revenue Act of 1928, with the result that subsections (b)(3) and (c)(1) of the same section apply.
Subsection (i)(1) provides:
(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form or place of organization, however*1442 effected.
Disregarding the contract of sale and giving the cryptic sign "Ex." the force of altering the written contract of subscription for stock, we find that what actually occurred was that Publications, Inc., purchased 600 shares of stock of the News Co. (part of which belonged to Miller and Hawk) for $375,000 cash, and acquired the remaining 200 shares from Miller and Hawk in exchange for 6,250 shares of its own common stock. Publications, Inc., was authorized to issue 150,000 shares of common stock. Of this amount it sold 49,988 shares to subscribers, issued 12 shares at its organization, reserved for other purposes 89,500 shares, and did not issue 10,500 shares. It also issued and disposed of 52,000 shares of its preferred stock. The News Co. has not been dissolved and, so far as the record discloses, except perhaps the personalty and realty which Miller and Hawk reserved the right to withdraw, it possesses the same property it had before its stock was sold and exchanged, and is doing the same business. There was no alteration in its corporate or capital structure. The only thing that was changed was the ownership of its stock.
There was no transfer of any of the*1443 assets of the News Co. to Publications, Inc., and neither the News Co. nor its stockholders came into control of Publications, Inc. There was no recapitalization of either corporation and there was no change in identity, form, or place of organization. So parts (B), (C), and (D) of subsection (i)(1) do not apply. Publications, Inc., did not acquire any, much less substantially all, of the assets of the News Co. It did acquire all the capital stock of the latter company. This fact, the petitioners insist, brings this case within the subsection. They further assert that if this is not sufficient, then, since Miller and Hawk exchanged one fourth of the capital stock of the News Co. for a comparatively small amount of the stock of Publications, Inc., there was a continuing interest on the part of the stockholders of the News Co. *1069 which converted what was a sale and exchange of stock into a reorganization.
In , the Supreme Court construed a provision of the Revenue Act of 1926 similar to that which we are called upon to apply. There the Court said:
The paragraph in question directs - "The term 'reorganization' *1444 means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation)." The words within the parenthesis may not be disregarded. They expand the meaning of "merger" or "consolidation" so as to include some things which partake of the nature of a merger or consolidation but are beyond the ordinary and commonly accepted meaning of those words - so as to embrace circumstances difficult to delimit but which in strictness cannot be designated as either merger or consolidation. But the mere purchase for money of the assets of one Company by another is beyond the evident purpose of the provision, and has no real semblance to a merger or conslidation. Certainly, we think that to be within the exemption the seller must acquire an interest in the affairs of the purchasing company more definite than that incident to ownership of its short-term purchase-money notes. This general view is adopted and well sustained in *1445 . It harmonizes with the underlying purpose of the provisions in respect of exemptions and gives some effect to all the words employed.
Tested by the above rules we find nothing in the facts of this case which bears any resemblance to a consolidation or a merger. The News Co. certainly was not consolidated with Publications, Inc., and there was no new corporation arising on the ruins of either or both. Neither was the News Co. merged into Publications, Inc. . When the Supreme Court speaks of the old company acquiring an interest in the new, it is referring to a case where something occurred which partook of the nature of a consolidation or a merger, and where, in the language of the Court in , the "interests of the stockholders and creditors of any company which disappears remain and are retained against the surviving or newly created company." Here no company disappeared. The creditors of the News Co. acquired no rights against Publications, *1446 Inc. Three fourths of the stockholders in amount of the News Co. had no rights against Publications, Inc., except to sell their stock for cash.
It is clear that the stockholders of the News Co., as a whole, had no right to acquire any interest in Publications, Inc. The News Co. was not a party to any of the agreements. The contracts of Miller and Hawk were personal to themselves. In the absence of anything *1070 bearing the slightest resemblance to a consolidation or to a merger, we are of opinion that the fact that the owners of one fourth of the stock of the News Co. exchanged that proportion of the stock for a small minority interest of the common stock of Publications, Inc., did not convert what was, in fact, a mere exchange of stock into a reorganization, as that term is defined in section 112(i) of the Revenue Act of 1928. Respondent is approved on this issue. ; ; .
Under the facts we have found with reference to the use by Henry C. Hawk of his automobile in his business, his executrix is entitled*1447 to take as a deduction the sum of $2,056.84.
Reviewed by the Board.
Judgment in Docket No. 60689 will be entered for the respondent. Judgment in Docket No. 60690 will be under Rule 50.