*10 Decisions will be entered under Rule 50.
Corporation A, a holding company, was merged into Corporation B, an operating company. In such reorganization petitioners exchanged common stock and preferred stock of Corporation A for common stock and debenture bonds of Corporation B. Held, that there was a business purpose in the merger and the transaction was a statutory reorganization under section 112 (g) (1) of the Internal Revenue Code and within the meaning of section 112 (b) (3) "stock or securities in a corporation a party to a reorganization * * * [were], in pursuance of the plan of reorganization, exchanged solely for stock or securities * * * in another corporation a party to the reorganization" and no gain or loss is to be recognized by reason of such exchange. Held, further, the debenture bonds received by petitioners in such exchange were not taxable as a dividend under section 115 (a) and (g).
*931 The respondent in these consolidated proceedings determined deficiencies in income tax, as follows:
| Petitioner | Docket No. | Year | Deficiency |
| H. Grady Manning Trust | 16249 | 1942 | $ 80,950.00 |
| Ruth Manning | 16250 | 1943 | 55,306.06 |
| Joy Manning Scott | 16251 | 1943 | 36,342.31 |
The deficiencies are due to several adjustments to the net income as disclosed by petitioners in their returns for the taxable years. The deficiencies principally result from respondent's determination that the petitioners, H. Grady Manning Trust and Ruth Manning, in 1942 realized taxable income to the extent of the face value of debenture bonds received during that year from the Lamark Co. in exchange for preferred stock of Southwest Hotels, Inc. surrendered therefor.
The petitioners by an appropriate assignment of error*12 contest this adjustment. Several other adjustments made by the respondent are not contested.
The year 1942 is involved due to the forgiveness feature of the Current Tax Payment Act of 1943 as to individuals.
The parties have stipulated, without purporting to construe in any way the will of H. Grady Manning and solely for the purpose of the computation to be made under Rule 50 in these proceedings, that if any amount of taxable dividend is determined by this Court to have resulted by virtue of the receipt by the H. Grady Manning Trust of $ 118,700 principal amount of 20-year 6 per cent debentures of Lamark, such amount of taxable dividend shall be considered taxable as ordinary income to the trustee of such trust, and not to Ruth Manning and Joy Manning Scott as beneficiaries of such trust. The parties have also stipulated that $ 3,561 of interest received by the H. Grady Manning Trust during the taxable year ended December 31, 1943, on this $ 118,700 principal amount of debentures shall be considered taxable to Ruth Manning and to Joy Manning Scott in the amount of $ 1,780.50 to each.
This leaves for our consideration the question of whether the trustee of the H. Grady Manning Trust*13 and petitioner Ruth Manning realized taxable income equivalent to dividend distributions during the taxable year 1942 to the extent of the face value of the debenture bonds of *932 the Lamark Co. received in exchange for preferred stock of Southwest Hotels, Inc. This depends upon the question of whether the transaction pursuant to which the debenture bonds were received in exchange constituted a tax-free reorganization within the provisions of section 112 of the Internal Revenue Code.
FINDINGS OF FACT.
The facts which were stipulated are so found.
The petitioners, Ruth Manning and Joy Manning Scott, are individuals who reside in Little Rock, Arkansas. The petitioner, H. Grady Manning Trust, is a trust created under the will of H. Grady Manning, deceased. Ruth Manning (Mrs. H. Grady Manning) is the duly appointed and acting trustee in succession of the trust.
The income tax returns of Ruth Manning and of Joy Manning Scott for the taxable years ended December 31, 1942, and December 31, 1943, and the fiduciary income tax return for the H. Grady Manning Trust for the taxable year ended December 31, 1942, were all filed with the collector of internal revenue for the district of*14 Arkansas.
Southwest Hotels, Inc. (hereinafter referred to as Southwest) was incorporated under the laws of the State of Delaware on December 21, 1929. Southwest's business was the holding of stock in hotel companies. Southwest was organized by H. Grady Manning and his associates as a vehicle for carrying out the plan which Manning and his associates had for the expansion of their hotel system.
Effective January 1, 1930, Southwest issued shares of its preferred and common stock to the shareholders of the Manning Hotel Co., the Lafayette Hotel Co., and the Majestic Hotel Co. in exchange for all the outstanding stock of the Manning Hotel Co. and the Lafayette Hotel Co. and 72.3 per cent of the outstanding stock of the Majestic Hotel Co. The Manning Hotel Co. operated the Hotel Marion in Little Rock, Arkansas; the Lafayette Hotel Co. operated the Hotel Lafayette in Little Rock; and the Majestic Hotel Co. operated the Hotel Majestic in Hot Springs, Arkansas.
The first addition to the Southwest hotel chain after the initial transactions attending the organization of Southwest was the leasing in 1930 of the William Len Hotel in Memphis, Tennessee. This hotel was leased under a long term*15 lease which was put into the William Len Hotel Co.
In 1932, H. Grady Manning and his associates negotiated for the acquisition of two additional hotels in Little Rock: The Albert Pike and the Ben McGehee. The owners of the Albert Pike Hotel were reluctant to take a stock interest in Southwest which had property interests in Memphis and Hot Springs, as well as in Little Rock, but they were willing to take stock in a company whose operations were confined *933 to Little Rock. This led to the organization of the Lamark Co. (hereinafter referred to as Lamark).
Lamark was incorporated under the laws of the State of Delaware on January 5, 1933, for the purpose of taking over the operation of three hotels in Little Rock and acquiring all the outstanding stock of a fourth. The Hotel Albert Pike was acquired from the Farrell Hotel Co. through the assumption of fixed obligations and the issuance of 100 shares of the capital stock of Lamark. The Hotel Marion and the other operating assets of the Manning Hotel Co. were acquired by Lamark through the issuance of 214 shares of its capital stock and the assumption of obligations. All the outstanding shares of the Lafayette Hotel Co. were*16 acquired by Lamark from Southwest in exchange for 186 shares of the former's capital stock. The Hotel Ben McGehee was acquired from the McGehee Hotel Co. for cash, notes payable over a period of years, and the assumption of obligations.
The Manning Hotel Co. was liquidated into Southwest as of January 1, 1937, with the result that at December 31, 1942, prior to the merger with Lamark, Southwest beneficially owned all the outstanding stock of Lamark.
The capital stock of Southwest consisted of common stock without par value and $ 8 preferred stock without par value. Just prior to the merger Southwest had outstanding 30,336 shares of common stock and 4,015 shares of $ 8 preferred stock. Of the preferred stock 1,000 shares had been held by the Lafayette Hotel Co. These shares were declared by the Lafayette Hotel Co. as a dividend in kind to its sole stockholder, Lamark, on December 28, 1942. They were eliminated in the merger and were not taken into account in the plan of merger and reorganization.
In 1930, Southwest sold at par an issue of $ 250,000 aggregate principal amount of 7 per cent secured gold notes. These notes were issued to obtain funds for adding two or three additional*17 floors to the William Len Hotel and for furnishing such hotel. The 7 per cent secured gold notes of Southwest were originally issued to a number of banks and to the principal stockholders of Southwest. H. Grady Manning, C. H. Moses, and J. W. House, three of the largest stockholders in Southwest, obtained the funds for purchasing the 7 per cent secured gold notes by borrowing the face amount of the notes from a bank at 7 per cent, depositing such notes as collateral for their personal notes to the bank.
H. Grady Manning died on September 4, 1939. After Manning's death the purpose for which Southwest had been organized, to be the holding company for a growing hotel chain, ceased to exist since the interested parties no longer wanted to expand but rather wanted to consolidate their position.
*934 On September 4, 1942, Lamark purchased for $ 208,500 cash the 100 shares of its capital stock which had been issued to the Farrell Hotel Corporation in 1933. Such shares were purchased for retirement and were cancelled. The Farrell group retained no financial interest in the Southwest group. The funds for the purchase of such stock were borrowed from a life insurance company which*18 loan was secured by a first mortgage on Lamark's hotel property.
Prior to the merger with Lamark, Southwest was strictly a holding company; it did not directly own any operating hotel property. In addition to its control through 100 per cent stock ownership in Lamark of the hotels owned directly or controlled by Lamark, Southwest controlled two hotels, the Majestic and the William Len, through stock ownership in other companies. Southwest also held all the stock of the Hotel Marion Garage Co.
Just prior to the merger with Southwest, Lamark owned directly three hotels and controlled another hotel through stock ownership. Lamark has owned and operated the Marion, Albert Pike, and McGehee Hotels and has owned all the outstanding stock of the Lafayette Hotel Co. from 1933 to the present time. Lamark also owned a bus terminal in Little Rock. Lamark was the principal operating company in the Southwest group.
The $ 8 preferred stock of Southwest was entitled in involuntary liquidation to $ 100 per share, plus unpaid cumulative dividends in preference to its common stock. On January 1, 1943, dividends on the preferred stock would have been in arrears for 11 3/4 years in the amount of*19 $ 94 per share, or a total of $ 283,410 for the 3,015 shares of preferred stock outstanding in the hands of stockholders other than Lamark. Nonpayment of dividends for four consecutive quarterly dividend periods had resulted in sole general voting rights having shifted from the common to the preferred stock of Southwest in 1932.
The 7 per cent secured gold notes of Southwest were dated February 1, 1930, and matured serially at the rate of $ 25,000 every 6 months, commencing August 1, 1930. The first default on this note issue, both as to interest and principal, occurred on August 1, 1930. At December 31, 1942, $ 39,560 principal amount of 7 per cent secured gold notes was outstanding and overdue as to principal. Past due interest had accrued on the 7 per cent secured gold notes in the amount of $ 65,074.69. At the time of the merger all the unpaid outstanding principal of, and nearly all of the interest due on, the 7 per cent secured gold notes were owed to stockholders of Southwest. Subscribers to the note issue other than stockholders, such as banks, had either been paid off or had transferred their interest in the notes.
The assets and liabilities of Southwest as of December*20 31, 1942, are as follows: *935
| Assets: | ||
| Cash -- Banks | $ 21,159.04 | |
| Advances -- Affiliated hotels | 35,668.85 | |
| Accounts rec. officers -- shareholders | 397.25 | |
| Stock -- Majestic Hotel Co | 145,332.74 | |
| William Len Hotel Co | 185,000.00 | |
| Lamark Co | 354,897.74 | |
| Marion Hotel Garage Co | 23,173.56 | |
| Total Assets | $ 765,629.18 | |
| Liabilities: | ||
| Accrued taxes | $ 191.92 | |
| 7% Debenture notes | 39,560.00 | |
| 7% Debenture notes interest accrued | 65,074.69 | |
| Acct. payable -- Lafayette Hotel Co | 63,600.00 | |
| Notes payable -- Lafayette Hotel Co | 32,000.00 | |
| $ 200,426.61 | ||
| Capital stock -- Preferred -- issued | 401,500.00 | |
| Common -- issued | 2,633.96 | |
| 404,133.96 | ||
| Surplus -- Operating | 47,225.61 | |
| Capital | 76,809.07 | |
| Liq. of subsidiary | (54,516.45) | |
| Revaluation | 91,550.38 | |
| 161,068.61 | ||
| Total Liabilities | $ 765,629.18 |
The 7 per cent secured gold notes of Southwest were secured by a pledge with a trust company of all of the shares held by Southwest in hotel companies and in the Hotel Marion Garage Co.
All of the operating properties in the Southwest group were mortgaged to secure*21 loans. During the entire period from the beginning of 1933 up to the time of the merger, the Marion, Albert Pike, and McGehee Hotels, owned by Lamark were subject to first mortgages, and the Albert Pike and McGehee were also during this period covered by second mortgages. At the time of the merger the Hotel Marion was also subject to a second mortgage. The Hotel Majestic was covered by first and second mortgages during the period from 1933 to the time of the merger. The Hotel Lafayette was covered by a first mortgage. The Hotel Marion Garage was also security for loans. The rates of interest on the various loans during the period in question ranged from four and one-half per cent to seven per cent.
Disregarding the Southwest 7 per cent secured gold notes, but including 4 per cent unsecured obligations of Lamark issued as dividends in 1936 and 1937 in the aggregate principal amount of $ 113,500 and retired by 1940, the aggregate amount of funded debt of the Southwest group as of the beginning of each calendar year from 1933 to 1942, inclusive, and as of the end of 1942, when the merger took place, the annual interest requirements on such indebtedness, the annual requirements *22 for the retirement of such indebtedness, and the amounts actually expended for the payment of interest on, and the retirement *936 of, funded debt of the Southwest group during the period 1932 to 1942, inclusive, were as follows:
| Debt at | Annual | |
| Year | beginning | interest |
| of year | requirements | |
| 1933 | $ 3,163,500.00 | $ 184,218.55 |
| 1934 | 3,112,250.00 | 179,997.87 |
| 1935 | 3,011,750.00 | 185,018.07 |
| 1936 | 2,888,350.00 | 158,014.58 |
| 1937 | 2,726,037.68 | 141,921.55 |
| 1938 | 2,631,311.83 | 133,642.90 |
| 1939 | 2,452,585.83 | 133,134.67 |
| 1940 | 2,202,317.35 | 105,436.69 |
| 1941 | 1,922,959.77 | 89,825.41 |
| 1942 | 1,691,780.49 | 88,137.37 |
| 1943 | 1,718,837.66 | |
| Total | ||
| Annual average for the ten years |
| Annual | Expended for | |
| Year | retirement | interest and |
| requirements | retirements | |
| 1933 | $ 79,392.02 | $ 223,568.55 |
| 1934 | 99,048.03 | 275,705.87 |
| 1935 | 111,107.44 | 296.543.07 |
| 1936 | 139,974.04 | 394,973.90 |
| 1937 | 229,376.62 | 351,028.40 |
| 1938 | 236,374.53 | 365,083.90 |
| 1939 | 172,761.48 | 327,182,15 |
| 1940 | 145,327.59 | 383.046.27 |
| 1941 | 150,685.87 | 299,205.69 |
| 1942 | 143,490.88 | 328,424.55 |
| 1943 | ||
| Total | 3,244,762.35 | |
| Annual average for the ten years | 324,476.24 |
The above figures for actual *23 amounts expended for the payment of interest on and the retirement of debt make allowance for the fact that bonds of the Lafayette Hotel Co. were purchased for retirement through the sinking fund at less than their face amount.
The hotel properties of the Southwest group were undermaintained at the time of the merger and had been undermaintained for some years prior thereto, and there was a large amount of deferred maintenance work which should have been undertaken.
Just prior to the merger Southwest had current assets of $ 57,225.14 and current liabilities of $ 225,270.47, or a ratio of current assets to current liabilities of about one-fourth to one. Southwest's cash amounted to $ 21,159.04.
Just prior to the merger Lamark had current assets of $ 441,232.10 and current liabilities of $ 241,206.21, or a ratio of current assets to current liabilities of about 1.8 to 1. Lamark had cash in the amount of $ 244,463.72. Because a good part of its current assets was in inventories and supplies, and because of the amount of its current liabilities, it did not have surplus cash.
Just prior to the merger there were a number of intercompany obligations in the Southwest group. Southwest owed*24 the Lafayette Hotel Co., a subsidiary of Lamark, a total of $ 95,600. The Lafayette Hotel Co. owed Lamark $ 25,119.26.
On December 31, 1942, prior to the merger of Southwest into Lamark, the earnings and profits of Southwest accumulated after February 28, 1913, amounted to $ 157,963.19. As of the same time the earned surplus of Lamark amounted to $ 508,264.13.
In 1942, the management of the Southwest group gave consideration to a program for simplifying the corporate structure of the group, improving its financial situation, and partially eliminating intercompany obligations. In this connection, the management consulted *937 counsel and accountants for the companies in the Southwest group. The main objectives were to eliminate a holding company whose existence had become unnecessary and undesirable, to eliminate the divident arrearages on the Southwest preferred stock, to restore voting rights to the common stockholders of Southwest, to take care of the indebtedness of the 7 per cent secured notes of Southwest, and, in general, to eliminate the unfavorable financial situation of Southwest whose current liabilities far exceeded its current assets.
The proposal made by the *25 management to the stockholders was that Southwest and Lamark be merged and specifically the proposal was that Southwest, the parent, be merged into its subsidiary, Lamark. It was thought desirable that Southwest be merged into Lamark, rather than that Lamark be merged into Southwest, for two reasons: (1) counsel advised the management that the only way legally to eliminate the dividend arrearages on the Southwest preferred stock was to merge Southwest into another corporation, with Southwest's existence terminating and the other corporation surviving; and (2) Lamark had outstanding mortgage loans secured by its hotel properties, whereas Southwest's notes were secured only by a pledge of personal property.
On December 28, 1942, the board of directors and the stockholders of both Southwest and Lamark, at special meetings, approved and adopted a "Plan of Merger and Reorganization of Southwest Hotels, Inc. into Lamark Company," dated December 28, 1942, and an "Agreement of Merger by and Between Lamark Company and Southwest Hotels, Inc.," dated and executed December 28, 1942. This agreement of merger was filed in the office of the Secretary of State of the State of Delaware, whereby, *26 as of December 31, 1942, Southwest was merged into Lamark under the General Corporation Law of the State of Delaware, Lamark being the surviving corporation. The plan of merger and reorganization provided for a new issue of 20-year 6 per cent debentures of Lamark in the aggregate principal amount of $ 301,500. The agreement of merger provided for new common stock of Lamark of the par value of $ 1 per share and such new common stock constituted the only stock of Lamark authorized under the agreement of merger.
In accordance with the plan of merger and reorganization and the agreement of merger, the holders of $ 8 preferred shares of Southwest received in exchange for each such preferred share $ 100 principal amount of 20-year 6 per cent debentures and 19 shares of common stock of Lamark. The holders of common stock of Southwest received in exchange for each such share two shares of common stock of Lamark. The certificates for $ 8 preferred stock and for common stock of Southwest were surrendered and cancelled.
*938 The allocation of debentures and common stock of Lamark between the preferred and common stockholders of Southwest was arrived at on the following basis: As the *27 preferred shares of Southwest were entitled in involuntary liquidation to $ 100 per share in addition to accrued dividends, in preference to its common stock, each share of Southwest preferred stock was allocated $ 100 principal amount of new Lamark debentures. The division of the common stock was made with two factors in mind, the unpaid cumulative dividends on the Southwest preferred stock, and the consolidated net worth or book value of Lamark and Southwest as represented in Lamark after the merger. The net worth in Lamark after the merger, on a book basis and eliminating intercompany accounts, was about $ 5 per share of common stock. Each share of Southwest preferred was, therefore, allocated 19 shares of new Lamark common aggregating in value about the amount of the unpaid cumulative dividends. The holders of the old Southwest common received shares representing the balance of the net worth in Lamark after the merger. In the merger the common stockholders of Southwest received slightly more than 50 per cent of the new common stock of Lamark giving them voting control of Lamarkvis-a-vis the preferred stockholders of Southwest.
The merger agreement dated December 28, 1942, *28 provided that the total number of shares of stock which the surviving corporation shall have authority to issue is 125,000 shares, all of which shares of stock shall be common stock of the par value of $ 1 each, amounting in the aggregate to $ 125,000. The agreement provided, in part, as follows:
(a) Each share of outstanding preferred stock of Southwest shall be converted into $ 100 principal amount of 20-year 6% debentures of the surviving corporation and 19 shares of the $ 1 par value common stock of the surviving corporation and each holder of shares of preferred stock of Southwest upon the surrender to the surviving corporation of his certificate or certificates for such shares for cancellation shall be entitled to receive 20-year 6% Debentures and $ 1 par value common stock of the surviving corporation in the ratios above provided.
(B) Each share of outstanding common stock of Southwest shall be converted into two shares of $ 1 par value common stock of the surviving corporation and each holder of shares of common stock of Southwest upon the surrender to the surviving corporation of his certificate or certificates for such shares for cancellation shall be entitled to receive*29 $ 1 par value common stock of the surviving corporation in the ratio above provided.
The merger of Southwest into Lamark (1) eliminated a holding company, Southwest, and made the principal operating company, Lamark, the top company in the hotel group; (2) eliminated the unpaid accumulated dividends on the old Southwest preferred shares, giving such stock shares of new Lamark common with respect thereto; (3) led to a merged corporation with current assets somewhat, though not greatly, in excess of its current liabilities; and (4) resulted in the partial elimination of intercompany obligations.
*939 Under the agreement of merger the obligations of Southwest with respect to its 7 per cent secured gold notes were assumed by Lamark. The entire overdue principal on such notes and most of the overdue interest were paid and discharged immediately after the merger. The annual interest requirement on the new Lamark debentures was $ 6 on each $ 100 principal amount of debentures as compared with annual cumulative dividends of $ 8 per share on the old preferred stock of Southwest. The new Lamark debentures have a term of 20 years. None of such debentures are redeemable prior to December*30 31, 1952, 10 years after the date of such debentures, except in the event of the liquidation of the company. Lamark has not been liquidated and all of the debentures are still outstanding.
Prior to December 31, 1942, Ruth Manning, the petitioner in Docket No. 16250, was the owner of 134 shares of $ 8 preferred stock and 611 shares of common stock of Southwest, and the petitioner H. Grady Manning Trust in Docket No. 16249, held 1,187 shares of $ 8 preferred stock and 11,377 shares of common stock of Southwest. Joy Manning Scott, the petitioner in Docket No. 16251, held no shares of either the $ 8 preferred stock or the common stock of Southwest. In exchange for the 134 shares of Southwest $ 8 preferred stock owned by her prior to the merger of Southwest into Lamark, Ruth Manning received 2,546 shares of common stock and $ 13,400 principal amount of 20-year 6 per cent debentures of Lamark, and in exchange for the 611 shares of common stock owned by her prior to the merger, Ruth Manning received 1,222 shares of common stock of Lamark. In exchange for the 1,187 shares of $ 8 preferred stock of Southwest held by the H. Grady Manning Trust prior to the merger of Southwest into Lamark, *31 said trust received 22,553 shares of common stock and $ 118,700 principal amount of 20-year 6 per cent debentures of Lamark, and in exchange for the 11,377 shares of common stock of Southwest held by the H. Grady Manning Trust prior to said merger, the trust received 22,754 shares of common stock of Lamark. Joy Manning Scott did not receive any 20-year 6 per cent debentures or any common stock of Lamark.
On February 23, 1943, the name of Lamark Co. was changed to Southwest Hotels, Inc.
The transaction whereby common and preferred stock of Southwest were exchanged for common stock and debenture bonds of Lamark had a legitimate business purpose and the above plan which was adopted and carried out effected a genuine reorganization within the contemplation of section 112 (g) (1) of the Internal Revenue Code. The plan was not adopted and carried out as a scheme or as a device to serve as a distribution of earnings equivalent to a dividend of either Southwest or Lamark to the stockholders of those corporations, or either of them, parties to the reorganization.
*940 The exchange of preferred stock of Southwest for common stock and debentures of Lamark and the exchange of common stock*32 of Southwest for common stock of Lamark were the exchange of stock in a corporation, a party to a reorganization, in pursuance of the plan of reorganization solely for stock and securities in another corporation, a party to the reorganization, as provided in section 112 (b) (3), Internal Revenue Code.
In his determination of the deficiency against H. Grady Manning Trust, the Commissioner added to the net income reported on the fiduciary return "(b) Debenture bonds as income $ 118,700.00." This adjustment he explained in the deficiency notice, as follows:
(b) Information submitted with the return filed for the trust for the taxable year ended December 31, 1942, disclosed that during 1942, 11,377 shares of common stock and 1,187 shares of preferred stock of Southwest Hotels, Inc. owned by the trust were exchanged for 45,307 shares of common stock and $ 118,700.00 in 6% debenture bonds issued by the Lamark Company. No income was reported with respect to this transaction on the theory that the exchange was nontaxable as part of a reorganization within the purview of section 112 (g) (1) of the Internal Revenue Code. It has been determined that the merger of the Southwest Hotels, Inc. *33 and the Lamark Company was not a nontaxable reorganization within the contemplation of section 112 (g) (1) and that the face value of the debenture bonds received, or $ 118,700.00, constituted a taxable dividend under section 115 (a) and (g) of the Internal Revenue Code.
In his determination of the deficiency against Ruth Manning, the Commissioner made a similar adjustment, except as to amount, and made a similar explanation of the adjustment.
In his determination of the deficiency against Joy Manning Scott, the Commissioner added to the income reported on her return for the year 1942 "(b) Trust income adjustment $ 60,715.39." The Commissioner explained this adjustment in his deficiency notice, as follows:
(a) As stated in item (b) of Schedule 1-L, it has been determined that $ 118,700.00 in 6% debenture bonds received by the H. Grady Manning Trust in 1942 constituted a taxable dividend distributable to the beneficiaries of the trust of which your portion was 50%. During 1943 the trust received on these bonds $ 3,561.00 in interest. Inasmuch as it was held that 50% of the bonds were distributable to you, one-half of the interest in question, or $ 1,780.50, was includible in your*34 taxable income for 1943. The interest income reported on your return for the taxable year ended December 31, 1943, has, therefore, been increased by an adjustment of $ 1,780.50.
OPINION.
The issue in these proceedings remaining after the stipulation is whether petitioners, The H. Grady Manning Trust and Ruth Manning, received taxable income in the year 1942 to the extent of the face value of debenture bonds received by them in that year from Lamark, together with common stock of Lamark, in exchange *941 for preferred stock of Southwest surrendered therefor. This, in turn, depends upon the question of whether the transaction whereby Southwest was merged into Lamark was a statutory reorganization within the meaning of section 112 (g) of the Internal Revenue Code, 1*35 and whether the exchange by the owners of preferred stock in Southwest for common stock and debentures in Lamark was a tax-free exchange within the provisions of section 112 (b) (3) of the Internal Revenue Code. 2
Respondent sets forth his position in his brief with respect to the reorganization of the two corporations and the exchange by the preferred stockholders of Southwest of their preferred stock for common stock and debentures in Lamark, as follows:
With respect to petitioners' first contention, namely, that the merger of Southwest into Lamark was a reorganization within the scope of section 112, respondent agrees that there was a literal compliance with the provisions of section 112 (g) (1) (A) and (D). There is no question that the merger met the required "continuity of interest." However, the transaction requires more than a literal compliance with the statutes. The entire transaction must be motivated*36 by a legitimate business purpose. Respondent contends that there was no legitimate business purpose for the issuance of the debenture bonds of Lamark in addition to its common stock.
We think respondent is entirely correct in conceding that the merger of Southwest into Lamark was a reorganization within the scope of section 112. Any one who reads the record in this case is bound to concede that fact -- any other conclusion would be impossible. But while respondent concedes there was a literal compliance with the reorganization provisions of the statute, he contends there was no legitimate business purpose which motivated the reorganization; hence it should not be recognized. Respondent relies principally on Gregory v. Helvering, 293 U.S. 465">293 U.S. 465; Bazley v. Commissioner, 331 U.S. 737">331 U.S. 737 and Adams v. Commissioner, (same citation) in support of his contentions.
We think respondent's foregoing contentions were completely disproved by petitioners at the hearing. Louis R. Myers, who was a director and vice-president of both Southwest and Lamark at the *942 time of the merger of Southwest into Lamark, explained*37 the business reasons which motivated the merger, as follows:
We felt in our meetings [board of directors] that it was certainly the wise thing to do to simplify our corporate structure, eliminate the inter-company obligations, and unify our situation and our control over the management.
* * * *
There were two principal reasons, as I recall. First, we had the large issue of preferred stock outstanding with its many years of accumulated unpaid preferred stock dividends, and lawyers advised us that the only way to effectively eliminate that and cut them off forever would be to merge into another or new corporation. That was one of the principal reasons and furthermore we did not like to disturb our first and second mortgage loans in the lending institutions that had loaned against the underlying properties.
G. Russell Brown, who was neither an officer, nor director, nor stockholder of either corporation but was an accountant for both Southwest and Lamark and who had much to do with working out the plan of merger, explained the motivating reasons which were behind it, as follows:
In the first place, Southwest Hotels was set up originally by Mr. Manning as a vehicle for the acquisition*38 of hotel properties and for the expansion of his hotel program. After Mr. Manning's death, the purpose of the Southwest Hotels had ceased to exist since the group no longer wanted to expand but rather wanted to consolidate its position; so the Southwest Hotels had debentures outstanding in some substantial amount, serial notes outstanding of substantial amounts on which there was several years interest; they had preferred stock outstanding on which there was some eleven or twelve years dividends due.
* * * so we felt it would be best to make the principal operating company [Lamark] the top company of the hotel group.
D. K. Holmes, who was secretary and treasurer of both Southwest and Lamark, testified and corroborated Myers and Brown in their testimony.
Against this testimony respondent offered nothing except the facts which have been stipulated. None of these stipulated facts contradict in the slightest degree, so far as we can see, the testimony to which we have just referred. There are no facts in the record from which we could make an inference that the plan of reorganization which was carried out was conceived for the purpose of disguising the distribution of a taxable dividend*39 to the stockholders of Southwest. Respondent argues that we should make such an inference, but if we did so such an inference would be absolutely devoid of any evidence to support it. A trier of the facts has no right to make inferences which are entirely contrary to the facts which have been proved. This, we decline to do.
On the facts we have found, and we now hold, that the merger of Southwest under the laws of Delaware into Lamark was a reorganization within the meaning of section 112 (g) and the exchange by the preferred stockholders of Southwest of their preferred stock for common stock and debentures of Lamark was an exchange which falls *943 directly within the provisions of section 112 (b) (3) and no gain or loss is to be recognized in such exchange, no other property having been received in the exchange. We further hold that the receipt by the preferred stockholders of Southwest of 20-year 6 per cent debentures of Lamark as a part of the securities for which they exchanged their preferred stock was not a taxable dividend as contended by respondent. Commissioner v. Kolb, 100 Fed. (2d) 920 and South Atlantic Steamship Line, 42 B. T. A. 705.*40 Cf. Commissioner v. Gilmore's Estate, et al., 130 Fed. (2d) 791, affirming 44 B. T. A. 881; Commissioner v. Webster's Estate, 131 Fed. (2d) 426. We think the cases of Bazley v. Commissioner and Adams v. Commissioner, both supra, relied upon by respondent are clearly distinguishable on their facts from the instant case, and we so hold.
The Commissioner is, therefore, reversed in his determination that the debentures of Lamark which petitioners received in the exchange are taxable as the distribution of a dividend.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * * *
(g) Definition of Reorganization. -- As used in this section (other than subsection (b) (10) and subsection (1)) and in section 113 (other than subsection (a) (22)). --
(1) The term "reorganization" means (A) a statutory merger or consolidation, * * * or (D) 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 shareholders or both are in control of the corporation to which the assets are transferred. * * *↩
2. SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * * *
(b) Exchanges Solely in Kind. --
* * * *
(3) Stock for stock on reorganization. -- No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.↩