*259 Decision will be entered under Rule 50.
1. A distribution by a corporation out of earnings and profits made as an integral part of a merger amounting to a tax-free reorganization and in order to equalize its assets with those of the other merging corporation, held to have had the effect of a taxable dividend within the meaning of Internal Revenue Code, section 112 (c) (2).
2. Contributions to a fire department benevolent association, held deductible as a charitable contribution under Internal Revenue Code, section 23 (o).
*510 These proceedings, consolidated for hearing and decision, challenge the correctness of respondent's determination of deficiencies in income tax for the period January 1 to November 30, 1941, as follows:
| Docket | ||
| Petitioner | No. | Amount |
| Isabella M. Sheldon | 6203 | $ 47,585.24 |
| Julia S. Ludwig | 6204 | 9,943.04 |
| Ralph C. Sheldon, Jr | 6205 | 271.97 |
The principal issue, common to the three cases, is the nature of the distribution by Post Publishing Co. to petitioners as its stockholders on September 30, 1941, of $ 101,713.02. Respondent determined that this distribution was a taxable dividend under section 115 of the Internal Revenue Code
An issue arising in Dockets 6203 and 6204*261 is whether contributions made during the period to the Jamestown Fire Department Association, Inc., are deductible under section 23(o) of the Internal Revenue Code.
Some of the facts have been stipulated; others have been presented by oral and documentary evidence.
FINDINGS OF FACT.
The stipulated facts are hereby found.
Petitioners are individuals residing in Jamestown, New York. Their income tax returns for the period January 1 to November 30, *511 1941, the period here involved, were filed with the collector of internal revenue at Buffalo, New York.
Post Publishing Co. (hereinafter referrd to as Post), a New York corporation, on and prior to September 24, 1941, published in Jamestown, New York, a newspaper called "The Post." The Journal Printing Corporation (hereinafter referred to as Journal), a New York corporation, was publishing in Jamestown, New York, a newspaper called "The Jamestown Journal," and was a competitor of Post.
Prior to September 24, 1941, Post had outstanding 1,500 shares of capital stock of a par value of $ 100 per share, owned as follows:
| Shares | |
| Isabella Sheldon | 701 |
| Her daughter, Julia Ludwig | 120 |
| Her son, Ralph Sheldon, Jr | 21 |
| Edward L. Allen, trustee of estate | |
| of Edward R. Allen | 320 |
| Clara F. Beach | 160 |
| Evelyn F. Beach | 160 |
| Wilson C. Price | 16 |
| J. Harold Swanson | 1 |
| J. Robert Nelson | 1 |
| 1,500 |
*262 Isabella Sheldon acquired her 701 shares by inheritance from the estate of Ralph C. Sheldon (her husband) on September 16, 1937, at a basis of $ 125 per share, a total of $ 87,625. Julia Ludwig acquired 70 shares on December 9, 1938, and 50 shares on December 31, 1940, all at $ 130 per share, a total of $ 15,600. Ralph Sheldon, Jr., acquired 20 shares on December 9, 1938, at $ 130 per share, $ 2,600, and one share on July 7, 1933, for $ 100, a total of $ 2,700.
Although they were not receptive to the idea of merging Post and Journal prior to 1941 sometime during 1941 petitioners became interested in such merger as a means of eliminating the competition that had developed between the two papers.
Horace L. Davis, a newspaper publisher of Appleton, Wisconsin, at the request of Julia Ludwig, came to Jamestown and represented petitioners in the negotiations with Hill, general manager of the Jamestown Journal, in formulating a plan of merger of the competing newspapers.
The Allen and Beach interests were apprised of the contemplated merger and they were offered the opportunity to participate. Without one of these interests the necessary vote of holders of two-thirds of the stock of Post, *263 required by the law of New York, could not be obtained. These interests did not desire to participate, but rather accepted the offer of petitioners Isabella Sheldon and Julia Ludwig, conveyed through Davis, to purchase their stock.
For a number of years prior to September 24, 1941, there had been a lack of harmony so far as the management of the Post was concerned between the Allen-Beach interests on the one hand and the Sheldon interests on the other. Earlier offers of the Allen-Beach interests to dispose of their stock in Post to the Sheldon interests were not accepted by the latter.
*512 The directors of Post had considered having Post purchase the Allen-Beach interests, but further action in this regard was rendered unnecessary by the sale of stock to two of the petitioners.
On September 24, 1941, Isabella Sheldon and Julia Ludwig each acquired 320 shares, at a cost of $ 260 per share, of the stock held by the Allen-Beach interests. At the same time Isabella Sheldon disposed of 10 shares to Davis at $ 130 per share. As a result of these transactions, the stock of Post was owned as follows:
| Shares | |
| Isabella Sheldon | 1,011 |
| Julia Ludwig | 440 |
| Ralph Sheldon | 21 |
| Wilson C. Price | 16 |
| H. L. Davis | 10 |
| J. Harold Swanson | 1 |
| J. Robert Nelson | 1 |
| Total | 1,500 |
*264 At the time of the purchase of the 640 shares, Isabella Sheldon and Julia Ludwig were aware that they would receive the equivalent of a substantial portion of the purchase price by a subsequent distribution to be made by Post to its stockholders.
On September 26, 1941, Post's stockholders executed a certificate, filed with the Secretary of State of New York, whereby the capital of Post was reduced from $ 150,000 to $ 97,500 by reducing the par value of each share from $ 100 to $ 65. The terms of exchange were one share of $ 100 par value for one new share of $ 65 par value.
The reduction of $ 52,500 in par value of capital stock was credited to capital surplus and debited to the capital stock account.
On September 30, 1941, there was distributed to the stockholders of Post, in proportion to stock ownership, the sum of $ 101,713.02 ($ 67.81 per share) consisting of cash, securities, and other property. The distribution was pursuant to the following resolution, unanimously adopted:
Resolved: That out of the surplus there be paid forthwith to the stockholders of record as of this date a dividend of the cash, securities and other property listed in Schedule "A", which is hereto attached*265 and made a part of this resolution, and that said property be distributed ratably to the stockholders in proportion to the respective stockholdings; and it is further
Resolved: That upon receiving receipts from the several stockholders for said dividend, the property, stock and securities be transferred to Wilson C. Price, nominee and agent for the said stockholders, to be by him held and disposed of for the benefit of the stockholders in proportion to their stockholdings.
Schedule A referred to in the resolution consisted of the following:
| Cash in First National Bank | $ 49,934.29 | ||
| United States Treasury Bonds | 1,114.05 | ||
| Other bonds | 17,124.75 | ||
| Mortgages | 7,750.00 | ||
| Corporation stocks | 27,118.70 | ||
| Real estate | 2,700.00 | ||
| Total | $ 105,741.79 | ||
| Less liabilities to be paid: | |||
| Balance due newsboys | $ 872.65 | ||
| Price & Miller | 999.36 | ||
| Federal capital stock tax | 125.00 | ||
| 1940 Federal income tax | 1,480.61 | ||
| 1941 Federal income tax | 551.15 | ||
| Total | $ 4,028.77 | ||
| Net amount of dividend | $ 101,713.02 |
*513 The distribution was debited on Post's books as follows:
| To earned surplus account | $ 58,749.32 |
| To capital surplus account | 42,963.70 |
The sum*266 of $ 101,713.02 was distributed by Post to its stockholders so as to equalize its assets with those of Journal at the time of the merger, it being intended for each company to contribute an equal amount of assets in the formation of the new corporation.
On September 30, 1941, the following plan of reorganization of Post and Journal by acquisition of their assets by a new corporation, to be known as Jamestown Newspaper Corporation (hereinafter referred to as the new corporation), was unanimously adopted at a special meeting of the stockholders of Post:
Plan of Reorganization
Purposes of Reorganization
To effect a merger of the Jamestown Post and the Jamestown Evening Journal for the purpose of continuing the publication of one or both newspapers from a single plant.
Method:
The merger will be effected by means of a statutory merger under the laws of the State of New York.
Procedure:
1. Since it appears desirable that the people of Jamestown should not get the idea that either the Post or the Journal is not in good financial condition, or has not been successful in operation, it is considered advisable that neither corporation should buy out the other. Nor should it appear that*267 in a consolidation either corporation would become the surviving corporation.
2. It is considered advisable that the two companies be brought together by means of a statutory merger in which both of the present corporations will be extinguished by being merged into an entirely new corporation whose stockholders will be the same individuals as the stockholders of the present corporations, and whose proportionate interests in the combined properties after the merger will be the same as their respective interests in the aggregate value of the combined properties prior to the merger.
3. It is recognized that there may be some differences in the book value of certain tangible assets of the two companies, such as quick assets, plant and equipment, but these differences are considered to be offset by differences in the value of circulation and good will. In particular, it is recognized that the Post has a larger circulation than the Journal, but much of the Post circulation is outside the city of Jamestown and consequently has a lower value per subscriber. The *514 press franchises of both newspapers have the same value. All things considered, it is believed that the aggregate value*268 of all the assets of each newspaper is so nearly the same as the other that it is difficult, if not impossible, to make a distinction in favor of either. Consequently, it seems proper that all the assets of each paper should be accepted as having the same value as the assets of the other.
4. It is considered that the combined aggregate value of the assets of both newspapers is not less than $ 700,000.00 on a conservative valuation of combined circulation, which is the sum of the values of $ 350,000.00 for each newspaper. In the contemplated merger the properties should be valued accordingly.
5. Because of the unusually complex economic conditions existing at the present time, and the financial hazard attending the publication of a newspaper, especially in possible libel suits and judgments from other actions at law which might imperil the financial condition of the combined newspapers, it is considered advisable that the proprietary interests of the owners shall not only be in the form of the equity represented by the capital stock of a corporation, but that such proprietary interest should also include a position or standing as general creditors which may be lawfully conveyed to*269 them by means of debenture notes to be issued by the new corporation as part of this plan of reorganization.
6. To accomplish the purposes set forth above, it is recommended:
(a) That the stockholders of both of the present corporations exchange their stock in the present corporations solely for stock and debenture notes of a new corporation, to be known as Jamestown Newspaper Corporation in the amounts set forth below:
| Stock | Debentures | |
| Post stockholders | $ 150,000.00 | $ 200,000.00 |
| Journal stockholders | 150,000.00 | 200,000.00 |
| $ 300,000.00 | $ 400,000.00 |
Now, in Reference to the Foregoing Facts, the following resolution was offered by Mr. Nelson, seconded by Mr. Swanson:
Be It Resolved: That this Board approve said foregoing statement and direct its officers to abide by and carry out such arrangement.
The certificate of merger was executed October 7, 1941, and was filed with the Secretary of State of New York on October 10, 1941.
Petitioners' shares of the $ 101,713.02 distributed were as follows:
| Isabella Sheldon | $ 68,554.59 |
| Julia Ludwig | 29,835.81 |
| Ralph Sheldon | 1,423.98 |
In filing their tax returns for the 1941 period involved, each of the petitioners applied*270 the amount received, the distribution from Post, as a return of capital, reducing the cost of the stock in Post.
Respondent determined as to each petitioner that the amount so received was income from dividends.
The original authorized capital of Post was $ 10,000, later increased to $ 30,000 and still later, in June 1921, to $ 150,000. At that time a nontaxable stock dividend of 1,223 shares, each having a par value of $ 100, was declared. Earned surplus was debited with $ 122,300 and capital stock account was credited with said amount.
*515 The earned surplus account before and after the distribution shows the following:
| Balance, Sept. 30, 1941 | $ 69,815.75 | |||
| Less: | ||||
| Adjustment in value of securities and | ||||
| property distributed in kind | $ 11,066.43 | |||
| Distributions charged to earned surplus -- | ||||
| Sept. 30, 1941: | ||||
| Cash | 49,934.29 | |||
| Property | 8,815.03 | |||
| 69,815.75 | ||||
| Balance | -- 0 -- |
The earned surplus of Post on March 1, 1913, was $ 33,397.24.
An analysis of the capital surplus of Post, before and after the distribution, is as follows:
| Credit resulting from reduction in capital stock | |
| from $ 150,000 to $ 97,500 | $ 52,500.00 |
| Distribution in property | 42,963.70 |
| Balance | 9,536.30 |
*271 For each share of $ 65 par value Post stock, each stockholder of Post received as part of the merger a unit having a fair market value of $ 196 and consisting of one share of $ 100 par value stock and debentures of a face amount of $ 133.33 of the new corporation.
Two sales of such units in the first half of 1942 were made by persons other than petitioners at a rate of $ 196 per unit.
Petitioners Isabella Sheldon and Julia Ludwig contributed $ 300 and $ 100, respectively, to the Jamestown Fire Department Association, Inc., (hereinafter referred to as the association) and deducted the same as charitable contributions, which were disallowed by respondent.
The association, a New York corporation organized pursuant to the Membership Corporations Law of New York, has as its purposes:
A. To promote and provide social relations, entertainment and recreation among its members, and, generally, to advance and provide for the welfare of its members; to increase the efficiency of the Fire Department of the City of Jamestown, New York.
B. To receive and pay out for the relief and benefit of its members and their families or representatives, all moneys which it may lawfully acquire in accordance*272 with the law * * *
C. To acquire and dispose of property of any sort, as may be required by the corporation to carry out the foregoing purposes.Its bylaws provided, among other things, as follows:
Membership.
All members of the Jamestown Fire Department, and all members of such department who are now, or hereafter, become retired on pension, shall be members *516 of the corporation, and be entitled to the benefits, as provided in these By-Laws or any amendments thereto. Upon severance from service in the Jamestown Fire Department, except by retirement on pension, all persons shall cease to be members and shall not hereafter be entitled to any benefits provided herein.
* * * *
Funds and Benefits.
Section 1. There shall be no dues or other fees for the members in the corporation but upon the death of any member there shall be a death assessment against each member of one dollar. Such death assessment now eliminated until referendum vote of entire membership and further notice.
Section 2. The corporation may, from time to time, conduct dances, entertainments, or engage in other functions, designed for the purpose of raising money, the proceeds therefrom to be a part of the*273 funds of the corporation, such funds to be held, invested and used for the purpose of paying the necessary expenses incurred in the operation of the corporation's business, for the purpose of decorating the graves of the deceased members of the Jamestown Fire Department on Memorial Day for the [sic] and purpose of paying benefits to members or their beneficiaries, as herein provided.
Section 3. The funds of the corporation may be invested from time to time by the Directors of the corporation, in such securities as are legal for a savings bank or trust company, within the State of New York, but no loan shall be made to any member of the corporation in any event whatsoever. All loans must be approved by a majority vote of the whole board of directors of the corporation.
Section 4. Each member may designate to the Secretary of the Corporation a beneficiary to whom the Secretary shall issue an insurance policy (group insurance), the sum of $ 500.00, said insurance policy to be kept enforced by the Jamestown Fire Department Association, Inc., as long as said member is a member of the Jamestown Fire Department or pensioner thereof. All members pensioned or retired before October 26th, *274 1940, at their death their beneficiaries shall receive the maximum of $ 300.00 which was paid at the time of changing to group insurances. This is to continue as long as funds are available. For all members delinquent in death assessments before above date their beneficiary to receive the sum of $ 100.00.
In the absence of such designation of beneficiary said sum shall be paid to the survivor of such deceased member in the event there is such a survivor in the following order: widow, child, mother, father, sister, brother.
Other benefits and services of the association included placing of markers on graves of deceased members, sending of wreaths to the family of such deceased, and decorating of graves of deceased members on Memorial Day.
No part of the expenditures of the association in 1941 was for purposes of entertainment or recreation of its members.
OPINION.
The parties appear to be in agreement that the exchange of stock of the old company for stock and debentures of the new was a tax-free reorganization under section 112. The controversy concerns a distribution of cash and other property received by petitioners as stockholders of the old company immediately prior to the *275 merger. *517 The purpose of this distribution, its place in the sequence of events, and the surrounding circumstances, lead to but one conclusion. They all demonstrate that it was an integral part of the reorganization transaction as a whole and must be treated in connection with it. Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179">315 U.S. 179, 185.
We accordingly concur in petitioners' assertion that this is a proper case for application of the principle that reorganization transactions are not to be broken down into their separate phases, but should be viewed as a whole. 1 We also agree that the substance of the transaction rather than its form, the ultimate result reached rather than the mechanics used, are significant. Nevertheless, both parties resort to section 115 for their respective positions and rely upon one or another of its subsections to support their divergent views. We think that both err in this respect, and that the inescapable characterization of this transaction as one covered by the reorganization provisions requires that it be dealt with under section 112 and limits any applicability of section 115 accordingly. Commissioner v. Estate of Bedford, 325 U.S. 283">325 U.S. 283.*276 It follows that neither respondent's attempt to characterize the entire distribution as a taxable dividend, under subsection (a) of section 115, nor petitioners' to limit the transaction to a distribution in partial liquidation under subsection (c) of the same section can succeed. Cf. Sidney S. Munter, 5 T.C. 108">5 T. C. 108; Spirella Co., 5 T.C. 876">5 T. C. 876.
Since there is no issue as to the exchange of securities and the controversy limits itself*277 to the cash and other property not permitted to be received without the recognition of gain, it is subsection (c) of section 1122*278 which is applicable. Both the language of subdivision (2) of that subsection and its legislative history 3 require that it be *518 applied to the present facts. Commissioner v. Estate of Bedford, supra.
*279 Petitioners insist that the transaction amounted to no more in substance than a purchase by their corporation of the stock of other stockholders. They rely for this conclusion upon Fox v. Harrison (C. C. A., 7th Cir.), 145 Fed. (2d) 521. There are at least two reasons why this approach seems inadmissible. Unlike the facts in the Fox case, these petitioners retained the shares which were purchased and did not turn them in to the corporation. It is scarcely logical to view their purchase as a step toward eventual acquisition by the corporation when the ultimate outcome was their retention of the property purchased or its proceeds. Moreover, the distribution of cash and other property was not solely to the stockholders who had purchased the stock, but was a ratable division among them all according to the proportions of stock ownership; and the amount which petitioners did receive was considerably less than the purchase price paid out by them. The factual consequence was precisely that of the distribution of a taxable dividend and not even approximately what would have resulted had these petitioners in fact been acting for the corporation as*280 they now claim to have been.
We think it clear that on the facts the distribution was for the purpose of equalizing the assets of the two merging corporations, not to reimburse petitioners for the purchase of the stock; that they purchased and retained the stock for themselves and not for the corporation nor for the other stockholders; and that the final result was, on the one hand, the acquisition and retention by them of a larger proportional interest in the old corporation, and, on the other, the receipt by them and the other stockholders of a distribution of the corporation's profits which was in all respects the equivalent of a taxable dividend. See William E. Fulton, 15 B. T. A. 1018; affd. (App. D. C.), 47 Fed. (2d) 436.
There seems no doubt that there were post-1913 earnings and profits which would have been available to cover the entire amount of the distribution -- a premise in which the parties apparently concur. The *519 taxable portion, however, is limited by the gain received by the respective petitioners from the transaction. The figures appear in our findings from which these amounts can be computed.
*281 Petitioners' contribution to the Jamestown Fire Department Association should be allowed as a charitable contribution under section 23 (o) (2). See S. [M.] 1202, 1 C. B. 148; Roy C. McKenna, 5 T. C. 712.
Decision will be entered under Rule 50.
Footnotes
1. Although respondent in terms denies this, it seems to us that he virtually concedes it when he says in his brief: "The true explanation of the distribution is that as part of the plan of merger↩, an effort was made to equalize the assets of the Post Publishing Company with those of the Journal Printing Company, and in order to do so, assets of a net value of $ 101,713.02 constituted excess assets of the Post Publishing Company, and as such were distributed to its stockholders as unnecessary to the merger." (Emphasis added.)
2. (c) Gain From Exchanges Not Solely in Kind. --
(1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (l), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (l) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
(2) If a distribution made in pursuance of a plan of reorganization is within the provisions of paragraph (1) of this subsection but has the effect of the distribution of a taxable dividend, then there shall be taxed as a dividend to each distributee such an amount of gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be taxed as a gain from the exchange of property.↩
3. Report of Ways and Means Committee (68th Cong., 1st sess., H. Rept. 179, pp. 14-15):
"(2) There is no provision of the existing law which corresponds to paragraph (2) of subdivision (d). This subdivision provides that any amount distributed by a corporation in connection with a reorganization which has the effect of a taxable dividend shall be taxed as a dividend and not as a taxable gain.
"The necessity for this provision may best be shown by an example: Corporation A has capital stock of $ 100,000, and earnings and profits accumulated since March 1, 1913, of $ 50,000. If it distributes the $ 50,000 as a dividend to its stockholders, the amount distributed will be taxed at the full surtax rates.
"On the other hand, corporation A may organize corporation B, to which it transfers all its assets, the consideration for the transfer being the issuance by B of all its stock and $ 50,000 in cash to the stockholders of corporation A in exchange for their stock in corporation A. Under the existing law, the $ 50,000 distributed with the stock of corporation B would be taxed, not as a dividend, but as a capital gain, subject only to the 12 1/2 per cent rate. The effect of such a distribution is obviously the same as if the corporation had declared out as a dividend its $ 50,000 earnings and profits. If dividends are to be subject to the full surtax rates, then such an amount so distributed should also be subject to the surtax rates and not to the 12 1/2 per cent rate on capital gain. Here again this provision prevents evasions."↩