*1121 1. Held, on the facts, that common stock of the Mountain Cross Granite Co. did not become worthless in 1930.
2. In 1930 the Mountain Cross Granite Co. was unable to continue operations without additional funds and a new corporation was organized to take over its property and business. The needed cash was obtained by the new corporation through the sale of a portion of its common stock to one of the old company's stockholders, who was a party to the plan, for $7.50 per share. Under the plan the stockholders of the old company subscribed for stock of the new company and, upon surrender of their old stock for cancellation, received common and preferred stock in the new company on the basis of rates specified for the stock and securities of the old company. In this exchange no value was given to common stock, but surrender of one share of old common along with senior securities was required for each share of new company common stock; and where stockholders held only common stock, such stock could be surrendered for warrants permitting the purchase of common stock in the new company at $7.50 per share. Only the stockholders in the old company participated in the organization*1122 of the new company. Held, that this transaction was a reorganization within the meaning of section 112(i)(1) of the Revenue Act of 1928, and that no gain or loss resulted from the exchange of stock or securities.
*319 This is a proceeding for the redetermination of a deficiency in income tax for the year 1930, in the amount of $4,967.02. The questions involved are (1) whether the Commissioner erred in *320 failing to allow as a deduction the sum of $125,000 representing the amount paid by the petitioner for common stock in the Mountain Cross Granite Co., a Colorado corporation, which stock the petitioner contends became worthless in 1930; and (2) whether this stock was exchanged for stock of another corporation in a taxable or nontaxable transaction.
FINDINGS OF FACT.
The petitioner is a citizen, residing in Wichita, Kansas. In 1927 he bought 1,000 shares of common stock of the Mountain Cross Granite Co. at $25 per share and in 1928 bought 4,000 additional shares at the same price. In 1929 he purchased, *1123 for $4,500, a $5,000 par value bond of the same company, and in the same year bought 600 shares of prior preferred stock for $60,000. With each share of prior preferred stock so purchased he received one share of class A common stock.
The Mountain Cross Granite Co. was incorporated under the laws of the State of Colorado in May 1924, as the Stonehenge Granite Co., with authorized capital stock of 10,000 shares of preferred stock of $100 par value and 20,000 shares of common stock of no par value. The preferred stock carried no voting power. The name of the corporation was changed to Mountain Cross Granite Co. in May 1929. At that time and thereafter, until July 1, 1930, the entire 20,000 shares of common stock authorized had been issued and were outstanding. The corporation was organized to engage in the production of granite for monuments and building purposes. Its properties were located near Salida, Colorado.
The petitioner considered the company to be financially sound until March 1930, when he received a report of an audit of its affairs. After studying this report carefully, he went to Denver for a meeting of the board of directors, at which time a thorough investigation*1124 of the condition of the company was made. This investigation disclosed that the company had an overdraft at the bank, pay rolls were unpaid, and a shut-down of the plant was impending. It owned valuable properties and a complete and modern plant, but business was dull and it was unable to obtain funds with which to pay its obligations and operating expenses.
After the meeting of the board of directors in Denver, the petitioner personally undertook to raise the needed funds. The banks would make no further loans and all efforts to sell additional securities failed. The petitioner then contacted R. C. Walgren of Chicago, Illinois, who owned 1,000 shares of prior preferred stock and 1,000 shares of class A common stock, but was unable to interest him in the purchase of bonds or other securities of the company.
*321 In May 1930 a communication was received from Walgren asking the principal stockholders to come to Chicago to consider a proposition he was willing to make. W. H. Wade, president of the company, Maud M. Moe, representing the L. L. Moe estate, and the petitioner, these three being the majority stockholders, attended the conference in Chicago, at which time*1125 Walgren submitted his proposition. The conditions and terms of this proposal are shown by a letter mailed by the board of directors to the stockholders of the Mountain Cross Granite Co. under date of May 26, 1930, as follows:
TO ALL STOCKHOLDERS OF THE MOUNTAIN CROSS GRANITE COMPANY:
Enclosed please find formal notice of the special meeting of stockholders called for Tuesday, July 1, 1930, at 10:00 A.M.
We are addressing this letter to all classes of stockholders of our company, although common stockholders are only legally entitled to vote. We desire that every stockholder be informed of the present affairs of the company, of the proposals which are being considered, and to be given the opportunity to attend a meeting of all stockholders, or be represented thereat by proxy.
PRESENT CONDITION OF THE COMPANY.
Your company has, we believe, practically unlimited granite of fine quality available in various colors and has a completed plant of modern type for working such granite. It has also carried on a small amount of production and sales such as to cause us to believe that the business can eventually be made successful. On the other hand, your company is without funds*1126 with which to carry on its business, and owes approximately $36,000 in addition to its bonded indebtedness. Of this $36,000, $26,000 is due to banks on short-term paper and most of the other $10,000, which is due creditors, is past due. Interest upon the company's bonds will be due on the first of July of this year. Operations from November 1, 1929 to March 31, 1930, show a loss of approximately $25,000. In our opinion $100,000 of new money is imperative immediately.
We have for some months been endeavoring, but without success, to raise funds for the company. It is impossible to sell senior securities owing to the existence of mortgage bonds and prior preferred and preferred stock. On the other hand, it is impossible to secure subscriptions for new common stock when such a large amount of prior securities are outstanding. We therefore recommend a reorganization of the company along the following lines:
(1) Incorporate a new company to be called Mountain Cross Granite Corporation, or some similar name, to the formation of which and to the use of which name this company will give its approval. This new company will have an authorized capitalization consisting of 10,000*1127 shares of Cumulative Preferred stock without voting rights, of $100 par value per share, with dividends at 8 per cent payable semiannually on the first of January and July of each year, cumulative from January 1, 1931, callable in whole or in part at any time upon thirty days' notice by the Board of Directors at $105 per share and accrued dividends, and entitled in the event of liquidation, whether voluntary or involuntary, to participate in the distribution of the company's assets to the extent of $105 per share and accrued dividends, and having set aside for its retirement the sum of 10 cents for each cubic foot of granite sold for monumental purposes after January 1, 1931, and so long thereafter as any of the Preferred stock *322 shall be outstanding. Also, 50,000 shares of Common stock without par value but with exclusive voting rights.
(2) To the stock of the new company, the following have agreed to make subscriptions as follows:
C. R. Walgren 13,000 shares of Common Stock at $7.50 per share in cash, a total of $97,500 cash, of which about $50,000 will be used to pay the abovementioned indebtedness and bond interest and the organization expenses of the new company, *1128 and the balance will be available as working funds to further the productive activities of the new company;
Also Mr. Walgren will take 8,000 shares of Common stock at $7.50 per share by the surrender of 1,000 shares of the prior preferred stock of this company taken at a valuation of $50 per share, and 1,000 shares of the Class "A" stock of this company taken at a valuation of $10 per share.
Mrs. L. L. Moe, as an individual, and as Administratrix of the Estate of L. L. Moe, deceased, W. C. Coleman and Will H. Wade, on their own behalf and for others, not less than 17,000 shares of Common stock at $7.50 per share, to be paid for by the surrender of the securities of the present company valued as follows:
First Mortgage 7% Bonds at par;
Prior Preferred stock at $50 per share;
Preferred stock at $33.33 per share;
Class "A" stock at $10 per share, and in addition to surrender for nothing 17,000 shares of the Common stock of this company.
All other stockholders are asked to subscribe for stock in the new company as follows:
For Common stock at $7.50 per share in cash or in senior securities of this company taken at $50 per share for Prior Preferred stock, $33.33 per share*1129 for Preferred stock and $10 per share of Class "A" stock, together with one share of the Common stock of this company for each share of the Common stock of the new company subscribed for; and for Preferred stock at par of $100 per share to be paid for by the surrender of the securities of the present company in accordance with the valuations above stated.
It is hoped that all stockholders will subscribe. Common stockholders who do not choose to make a cash subscription to Common stock in the new company and have no senior securities of the present company with which to make their subscription may secure in exchange for their Common stock in the present company, warrants entitling them to purchase Common stock of the new company, in a number of shares equivalent to that held in the present company, at $7.50 per share, plus 6% interest accruing from July 1, 1930, to the date of exercise of such warrants. Warrants shall not be issued entitling the holders to purchase more than a combined total of 3,000 shares of the Common stock of the new company, and of the warrants so issued, which each person shall receive, one-third shall become void after July 1, 1931, one-third after July 1, 1932, and*1130 the remainder after July 1, 1933.
The new company formed and its stock subscribed for as above stated, it will offer to buy all the property and assets, including good will, trade reputation, etc., of the present company and assume all of the latter's liabilities as set forth on the books of said company, including the assumption of its first mortgage bonds in an amount not exceeding $80,000 par value, and the securities of the new company to be exchanged for those of the present company upon the basis and at the valuations above stated. Stockholders will be asked to vote upon the acceptance of this proposal. If it is for any reason not practicable to sell the assets of the company as above provided, then the *323 new company will propose to lease from the present company for a period of ten years all of its property of every kind, including the right to quarry and sell granite, upon the agreement of the new company to pay to the present company its taxes, its insurance, the proper maintenance of its plant (ordinary wear and tear excepted), its bond interest when and as due, and 50 cents per cubic foot for all granite sold and shipped.
As stated, one or the other of*1131 the two above propositions will be submitted to vote at the meeting.
ACTION OF PRINCIPAL STOCKHOLDERS.
As you will see from the foregoing, the principal stockholders of your company are showing their faith in the company by sacrificing most of their senior securities which they have and taking common stock for same. Mr. Walgren is putting in a large amount of new money and is surrendering prior Preferred stock at a large discount and will own only Common stock of the new company. Mr. Coleman is exchanging bonds and Preferred stock of the present company for Common stock of the new company at a great sacrifice. Mrs. Moe, both as an individual and as Administratrix of the Estate of L. L. Moe, is taking the same action, and so are Will H. Wade, D. T. Pulliam, Frazier Arnold, S. S. Sherman, Lee A. Moe, Rufus G. Gentry, Edwin H. Park, Guy W. Cooke, James E. Verre, Charles P. Davis, S. B. Walker and Felix M. McWhirter. The principal stockholders of the company could hardly demonstrate their confidence any more tangibly.
MANAGEMENT.
Mr. Wilbur B. Foshay has been asked to undertake the management of the new company and has agreed to do so. Mr. Will H. Wade will remain in the*1132 service of the company. Both Mr. Foshay and Mr. Wade will accept very moderate salaries. An agreement will be made between the new company and Mr. Foshay whereby the latter will have an option to purchase Common stock in the new company, such option being exercisable in not less than three years nor more than five years from July 1, 1930. The amount of Common stock of the new company which Mr. Foshay may purchase will be based on the net earnings made available to Common stock of the new company during the term of the above option. All subscribers to the Common stock of the new company who so desire may secure full particulars of the proposed agreement between Mr. Foshay and the new company by communicating with the undersigned. Mrs. Moe and Mrs. Coleman, Wade and Walgren, who will between them own most of the Common stock of the new company, have agreed to consummate the proposed arrangement between the new company and Mr. Foshay, as they believe that it will make for success of the new company.
RECOMMENDATIONS.
Your Board of Directors recommend that all stockholders exchange their stock of the present company for the common or preferred stock of the new company. We believe*1133 that, with the $97,500 new money and the lowered prior charges, the new company will have a substantial assurance of success. We also recommend that stockholders vote to sell the assets of the present company to the new company. If you are able to be present at the meeting, please do so. If not, please sign the enclosed proxy. We recommend that you also sign and forward the form of agreement enclosed herewith to exchange your stock into the stock of the new company.
*324 Proxy and subscription blanks are enclosed in duplicate so you may retain a copy for your files. Self-addressed return stamped envelope is also enclosed for your convenience.
Yours very truly,
By order of the Board of Directors:
W. C. COLEMAN, Chairman of the Board.
WILL H. WADE, President.
Subsequently, on July 1, 1930, a meeting of the stockholders was held in Denver, Colorado, to consider Walgren's proposal. At this meeting, 19,375 shares of the total 20,000 shares of common stock outstanding were represented. A resolution accepting the proposition was adopted unanimously. This resolution shows that 17,000 or more shares of the 20,000 shares of common stock of the new company, *1134 the Mountain Cross Granite Corporation, available to subscription by the stockholders of the old company, had already been subscribed in accordance with the plan submitted, one of these subscribers being the petitioner.
The proof shows that by July 31, 1930, all but 1,950 shares of the common stock of the new company available to the stockholders of the old company had been issued in accordance with the plan. Outstanding bonds of the old company amounting to $80,000 had been assumed, while the remaining bonds of the old company, amounting to $40,000, including the $5,000 bond of the petitioner, had been converted into common and preferred stock, in accordance with the plan, and all of the holders of the common stock of the old company as of June 30, 1930, except the holders of 950 shares, were represented in the new company as holders of common or preferred stock, or both. There is nothing in the record to show whether or not these 950 shares of common stock had been surrendered for warrants entitling the holders to subscribe for common stock of the new company. On the same date, July 31, 1930, only 981 shares of class A common stock out of a total of 9,460 shares, 974 shares*1135 of prior preferred stock out of a total of 4,715 shares, and 900 shares of preferred stock out of a total of 1,746 shares of the old company outstanding as of June 30, 1930, were not represented in the new company as holders of common or preferred stock.
The taxpayer surrendered his stock and bonds in the old company in accordance with the plan adopted and in return therefor received 38 1/3 shares of preferred and 6,156 shares of common stock in the new company. He did not pay any cash or property other than the stock and bonds of the old company for the shares received. No cash was paid into the new company except that paid by Walgren for the 13,000 shares of common stock previously mentioned, and by the holders of common stock warrants.
*325 The balance sheet of the old company as of June 30, 1930, shows liabilities in excess of assets and does not reflect any book value for common stock.
OPINION.
TURNER: It is the contention of the petitioner that the common stock of the Mountain Cross Granite Co. became worthless in 1930, and the cost of such stock to him was a deductible loss in that year. The respondent, in his deficiency letter, disallowed the deduction*1136 claimed, on the ground that the stock did not become worthless in 1930, and, further, determined that the stock was exchanged within that year for stock of another corporation, within the meaning of section 112(b)(3) of the Revenue Act of 1928.
It is apparent that the facts do not support the petitioner's claim that the common stock of the Mountain Cross Granite Co. was worthless at the time of or prior to the organization of the successor company. It is true that the company was in straits for operating funds and that it had pressing obligations. It is also true that on June 30, 1930, the day prior to the transfer of its business to the new corporation, the balance sheet did not show any book value for the common stock. This might be taken as an indication that if the company had been dissolved and its assets distributed at that time, the holders of common stock would have received nothing for their stock. The fact is, however, the company was not dissolved and its assets distributed, but a new corporation was formed to continue the business and the stockholders received an interest in the new company for and on the basis of their stockholdings in the old company. It is also*1137 to be noted that the company owned valuable properties which it was believed could be profitably operated if immediate and pressing obligations could be cared for. Furthermore, the holders of common stock had absolute control of these valuable properties, the preferred stock having no voting power whatever. That some value was attributed to the common stock is also shown by the facts that the plan for acquisition of the property by the new company, Mountain Cross Granite Corporation, required the surrender of one share of common stock for each share of common stock in the new company subscribed for by the holders of common stock in the old company.
There is the further fact that, to holders of common stock who held no so-called major securities, warrants were issued giving the right to subscribe to common stock of the new company at $7.50 per share. In this connection the petitioner cites the decision of the Board in , where it was held that the common stock of the old corporation was worthless prior to reorganization *326 and its cost constituted a deductible loss even though holders of such stock were later permitted to*1138 subscribe to common stock of the new corporation at the rate of $20 for units of 2 shares each. In that case, however, it appears that people not connected with the old company in any way, and not parties to the reorganization or underwriting agreement, were permitted to subscribe to common stock on the same basis as the holders of the common stock in the old company, and we found, as a fact, that the right to purchase two shares of stock in the new company at $20 had no market value. Here such was not the case. Only stockholders of the Mountain Cross Granite Co. were permitted to subscribe for stock in the Mountain Cross Granite Corporation. Even R. C. Walgren, who put the additional cash into the enterprise, was a holder of prior preferred and class A common stock and, except for Walgren, it does not appear that any person other than those who bought common stock under the right of common stock warrants put anything into the new company other than stock or bonds of the old company. Furthermore, there is no showing of the condition of the new company after the scaling down of the bonded indebtedness and the preferred, prior preferred, and class A common stock. Under such circumstances*1139 the record does not support the contention that the holders of common stock in the old company did not receive for their stock something of value in the warrants permitting the purchase of common stock in the new company at $7.50 per share.
Based on these considerations, it is our opinion that the common stock of the Mountain Cross Granite Co. did not become worthless in the year 1930 and that the petitioner did not sustain a deductible loss on that account.
Since it is the petitioner's contention that the common stock of the Mountain Cross Granite Co. was not exchanged for stock or securities of the Mountain Cross Granite Corporation, by way of reorganization or otherwise, and since we have found that the stock was not worthless in 1930, it might be sufficient to consider this case disposed of on that point alone. In view of the fact, however, that the deficiency letter, which is incorporated as a part of the petition, indicates that respondent's determination was based largely on a contention that petitioner's stock was exchanged for stock by way of a reorganization within the meaning of the statute, it is deemed necessary to determine the question as to whether an exchange*1140 of stock and securities did take place, and, if so, whether it was a non-taxable exchange, as shown by respondent's determination, or an exchange resulting in the realization of gain or loss.
Section 112(b)(3) of the Revenue Act of 1928 provides in part as follows:
*327 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.
The term "reorganization" is defined in section 112(i)(1) of the act in the following manner:
(i) Definition of reorganization. - As used in this section and sections 113 and 115 -
(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), *1141 or (B) a transfer by a corporation of all or a part of the 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 effected.
It is our opinion that the transaction whereby the Mountain Cross Granite Corporation was organized and acquired the assets of the Mountain Cross Granite Co. clearly comes within the meaning of section 112(i)(1) quoted above. We have pointed out, in , and , that in a strict merger "one of the corporations loses its identity by merging into another which survives and absorbs the property and assets of the merged corporation", but that Congress extended the term reorganization beyond strict mergers and consolidations by inserting the parenthetical clause in section 112(i)(1) to provide that mergers and consolidations included "the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number*1142 of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation." Referring to the language just quoted, the Supreme Court, in said:
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.
*328 It is essential, however, as was pointed out in , that there be a "continuity of interests under modified corporate forms."
In the light of these decisions and on the facts, there can be no doubt that the transaction here involved, even if not a strict merger, constituted a reorganization within the meaning of section 112(i)(1)(A) of the Revenue Act of 1928. Prior to the transaction of July 1, 1930, the petitioner*1143 and his associates held stock and securities of the Mountain Cross Granite Co., which owned certain assets and had certain liabilities. After that date they held, in the place of such stock and securities of the Mountain Cross Granite Co., stock of the Mountain Cross Granite Corporation, which owned the same assets subject to the same liabilities as before.
Regardless of the short cut taken in effecting the issuance of the stock of the new company and its procurement of the assets of the old company, the result, so far as the application of the statute here involved is concerned, is exactly the same as if there had been an actual exchange of the stock of the new company for the stock of the old company, or an exchange of the stock of the new company directly for the assets of the old company, and then a distribution of the new stock. It matters little that the plan of reorganization provided that the stockholders of the old company, instead of transferring their securities to the new company in exchange for its stock, should receive their stock in the new company upon surrender of the old company stock to the old company for cancellation and it does not change the situation in*1144 the least that a formal transfer of assets was made by the directors of the old company, reciting as consideration the agreement of the new company to assume the old company's liabilities. The final result by either course would have been exactly the same.
Neither do we consider that this transaction, on the facts disclosed, was any the less a reorganization within the meaning of section 112(i)(1)(A) because the new corporation sold some of its stock to R. C. Walgren for cash.
The stock, both common and preferred, and securities of the Mountain Cross Granite Co. were exchanged for stock of the Mountain Cross Granite Corporation within the meaning of section 112(b)(3) of the Revenue Act of 1928, and since we have already found that the common stock did not become worthless prior to such exchange, the petitioner did not sustain a deductible loss in 1930 with reference to such stock.
Reviewed by the Board.
Decision will be entered for the respondent.
BLACK, SMITH, and ARUNDELL dissent.