*1270 1. In 1937 the petitioner, at a cost of $20,413.80, acquired certain contracts from the Keedoozle Corporation for the operation of food stores by the use of electrical devices. At the time such method of operation was in an experimental stage. During the latter part of 1937 the Keedoozle Corporation abandoned its efforts to perfect the electrical devices. The petitioner, upon learning of such abandonment, charged off as a loss its investment in the contracts. Held, that the loss was sustained in 1937.
2. In 1937 the petitioner elected to redeem its outstanding 8 percent and 7 percent preferred stock, which was callable at a premium. It offered each of such preferred stockholders the right to receive new shares of 6 percent preferred stock, share for share, the premiums to be paid in cash to the extent of full shares covered by the holdings of each stockholder or in lieu thereof to receive additional full shares of 6 percent perferred stock and cash for fractional shares. The holders of 4,567 shares elected to receive the new 6 percent preferred stock, share for share, and a majority of them to receive the premiums in such preferred stock to the extent permitted. These*1271 4,567 shares were exchanged for 4,761 shares of the 6 percent preferred stock and cash in the amount of $6,300. The holders of 234 shares neglected to make any election and their shares were called for redemption and paid in cash to the extent of $23,400 for the par value of the shares, plus $1,480 cash for premiums. All of the cash distributions by the petitioner in the amount of $7,780 were charged against earned surplus. In its income tax return the petitioner claimed as dividends paid credit in the amount of the premium shares of $19,400, plus the cash distribution of $7,780; total $27,180. Held, that the petitioner is entitled to a dividends paid credit for the cash paid in the amount of $7,780, but not for the $19,400 for which new shares were issued.
*799 This is a proceeding for the redetermination of a deficiency in income tax (normal tax and surtax on undistributed profits) for 1937 in the amount of $8,603.94. The petition alleges that the respondent erred in his determination*1272 of the deficiency by disallowing the deduction from gross income of a loss of $20,413.80 in connection with an investment of that amount in contracts involving the right to license others and to operate stores under a trade name and to use certain inventions in stores under the name of "Keedoozle", which loss the petitioner contends was sustained in 1937.
By an amendment to his answer the respondent claims an increased deficiency by reason of failing to reduce the dividends paid credit claimed by the petitioner from $191,581.72 to $164,401.72, the difference representing the amount of premium on the redemption of the petitioner's 8 percent and 7 percent preferred stock, a part of the premiums being paid in cash and a part by issuance of shares of 6 percent preferred stock.
The evidence consists of a written stipulation of facts (incorporated in our findings of fact by reference) and oral testimony.
FINDINGS OF FACT.
Petitioner is a Texas corporation, with its principal office and place of business at Houston, Texas. It filed its income tax return for 1937 with the collector at Austin.
The petitioner was organized March 20, 1914. From the date of its organization it*1273 has been engaged in the operation of a chain of retail food stores at Houston. In addition to the sale of food products the petitioner operates a bakery, lunch counters, and drug departments. It advertises that its chain consists of "A Dozen and One Stores." These are self-service stores; that is to say, the customer selects merchandise from shelves, takes it to the cashier in a basket, and pays for it when bagged by the cashier.
In 1937 Joe Weingarten, the president of the petitioner corporation, was in Memphis, Tennessee, to observe the operation of a new system *800 of merchandising which was being brought out by Clarence Saunders, the founder of "Piggly-Wiggly Stores." It was Saunders' idea that instead of having the customer select merchandise from the shelves and bring it in a basket to the cashier, the customer would make his selection of the merchandise and by an electrically operated device the merchandise would be assembled at the cashier's desk where it would be bagged and paid for by the customer. For the operation of such a store the merchandise was displayed on shelves which were enclosed by glass. A customer upon entering the store would select a key from*1274 the cashier's desk, go about among the shelves and insert the key at a point indicated for the purchase of an article of merchandise. After he had made his selection of numerous articles of merchandise he took the key to the cashier who, with a master key, inserted it at a given point whereupon the merchandise which had been selected by the customer would be brought on a converyer belt to the cashier's desk and there bagged for the customer. Joe Weingarten thought that this novel method of merchandising would appeal to the public and that stores operated on this system would be profitable. The customer would be saved the necessity of bringing the merchandise to the cashier's desk. At the time Saunders had only one store in operation. It was then in an experimental stage. The Keedoozle Corporation had been organized by Saunders to exploit the invention.
After some negotiations Weingarten, acting for the petitioner, entered into a contract on May 7, 1937, with the Keedoozle Corporation whereby the petitioner was to have the exclusive right to operate Keedoozle stores in the counties of Harris, Galveston, Orange, and Jefferson, in the State of Texas, the contract giving the petitioner*1275 the right to any improvements upon the invention.
The petitioner paid $5,000 for the contract.
On June 30, 1937, an additional contract was entered into between the petitioner and the Keedoozle Corporation by which the prior contract of May 7, 1937, was superseded. Under the new contract the inventions were more specifically mentioned as of an electrical and mechanical nature to be used in store operations, as set forth above. Under this last contract the Keedoozle Corporation granted the petitioner the exclusive right throughout the State of Texas to the use of the word "Keedoozle" and to the use of the claimed inventions and devices in effect at that time and used in such store operations or improvements that might come into being in connection therewith. The Keedoozle Corporation also agreed to file applications for patents within a reasonable time on the above referred to electrical and mechanical devices and to use all efforts to obtain the necessary patents without delay. Under this contract the petitioner *801 was to receive one-half of the amounts realized from the State of Texas from (a) franchise fees; (b) license fees - to be one-half of 1 percent of the*1276 gross sales; (c) sums paid as liquidated damages; and (d) profits made by Keedoozle Corporation on fixtures and equipment installed in such stores. The petitioner paid Keedoozle Corporation the sum of $12,500 on June 29, 1937, as additional consideration for this contract.
On October 12, 1937, an additional contract was entered into between the Keedoozle Corporation and the petitioner which extended the contract of June 30, 1937, so as to include also the State of Oklahoma, and, on October 13, 1937, petitioner paid to the Keedoozle Corporation an additional amount of $2,500. It also paid attorneys' fees in the amount of $413.80 in connection with the acquisition of these contracts. Its total investment in the contracts was, therefore, $20,413.80.
In November 1937 Clarence Saunders and the Keedoozle Corporation stopped their work on the electrical devices and started work on hand or mechanically operated devices which were materially different from the automatic delivery devices in that, instead of having an automatic delivery, it was necessary to have an employee fill the order by taking the merchandise from the shelves after the list had been handed him. This was a complete*1277 abandonment of the devices which Saunders had been trying to perfect. Weingarten had no faith in these new devices. The store operated by the new devices was more expensive to operate than the self-service system which the petitioner was using in its stores.
Since Saunders had abandoned his attempt to perfect the stores of the type which Weingarten approved, the petitioner was of the opinion that its investment in the contracts was an utter loss in 1937 and, accordingly, charged it off as a loss in that year. The deduction of the claimed loss has been disallowed by the respondent in the determination of the deficiency.
In 1938 Saunders continued experiments with the electrical devices which had interested Weingarten in 1937. He continued to experiment with one store in Memphis along these lines until some time in 1940, when the effort was abandoned. The petitioner never received any equipment or any benefit from the Keedoozle Corporation under its contracts.
Prior to May 5, 1937, the petitioner had issued and outstanding the following shares of 8 percent and 7 percent preferred stock:
| 8% voting cumulative preferred stock | 635 shares |
| 8% nonvoting cumulative preferred stock | 2,443 shares |
| 7% nonvoting cumulative preferred stock | 1,723 shares |
| 4,801 shares |
*1278 *802 These shares all had a par value of $100 per share and had been issued either for cash at par or for property at par. There were no unpaid accrued dividends on the stock at May 5, 1937. All of the shares were redeemable at $105 per share except the 635 shares of 8 percent voting preferred stock, which were redeemable at $110 per share on any dividend date.
The petitioner had prospered. From the date of its organization in 1914 it had accumulated an earned surplus of approximately $450,000. Its income tax return for 1937 showed a net income of $289,622.86. The petitioner desired to call in its 8 percent and 7 percent perferred stock and to increase its issue of 6 percent preferred stock which was outstanding at the time in the amount of 2,500 shares of a par value of $100 per share. Certain officers of the petitioner had approached one of the preferred shareholders who owned or had under his control 2,075 shares of the 8 percent and 7 percent preferred stock. This stockholder orally agreed to exchange his preferred stock for an equal number of shares of the new 6 percent cumulative preferred stock to be issued.
On May 5, 1937, at a special meeting of the stockholders*1279 of the petitioner, a resolution was adopted reading in part as follows:
NOW THEREFORE, BE IT AND THE SAME IS HEREBY RESOLVED by the stockholders of the corporation that the directors be and they are hereby authorized and directed to take such steps as may be necessary to cause all of such outstanding 8% Cumulative Preferred stock and all of such 8% Non-Voting Cumulative Preferred Stock, and all of such 7% Non-Voting Cumulative Preferred stock of the corporation to be retired, giving to the holders thereof an option to either exchange the same for such new 6% Cumulative Non-Voting Preferred Stock when issued by accepting dollar for dollar such 6% Cumulative Preferred Stock for the amount of the par value plus premiums of such 8% and 7% Preferred Stock so held, except insofar as the same might require fractional shares, in which event the difference would be paid in cash, and to cause to be redeemed by payment in cash such portion of any such 8% or 7% Preferred Stock as the holders thereof may not desire to so exchange, as, if and when the corporation is authorized to issue such new 6% Non-Voting Cumulative Preferred Stock, and, in order to accomplish the foregoing, the directors of*1280 the corporation are hereby authorized and directed to file proper amendment to the charter of the corporation whereby in addition to the present 6% Cumulative Non-Voting Preferred Stock the Corporation shall be authorized to issue an additional 6,000 shares of such 6% Non-Voting Cumulative Preferred Stock of the par value of $100.00 per share, the certificates so evidencing such new issue of 6% Non-Voting Voting Cumulative Preferred Stock to contain substantially the same terms and provisions as those evidencing the present outstanding 6% Non-Voting Cumulative Preferred Stock; and
BE IT AND THE SAME IS HEREBY FURTHER RESOLVED that if, as and when such amendment to the charter of the corporation be made by the directors and accepted by the Secretary of State of the State of Texas, the directors shall be and they are hereby authorized, in behalf of the corporation, in payment for so much or such additional 6% Non-Voting Preferred Stock as may not be so exchanged to transfer from the surplus and undivided profits account of the *803 corporation to the capital account thereof such sum, if the same be sufficient, but if it be determined by the directors that the amount of the surplus*1281 and undivided profits of the corporation will not be sufficient to pay for such amount of additional 6% Non-Voting Preferred Stock which may not be so exchanged, then, to the extent of the difference, the directors shall and they are hereby authorized to cause such amount necessary to be subscribed by such person or persons as to them may seem fit and proper;
AND BE IT AND THE SAME IS HEREBY FURTHER RESOLVED that to the extent that such additional 6,000 shares of 6% Non-Voting Cumulative Preferred Stock shall be paid for from the surplus and undivided profits of the corporation, if, as and when such amendment to the charter of the Corporation be made by the directors and accepted by the Secretary of State of the State of Texas, the directors shall be and they are hereby authorized, in behalf of the corporation and for its benefit, to offer for sale at such price as to the directors may be deemed advisable and to sell and cause to be issued to such person or persons as they may deem fit and proper, all of such additional 6,000 shares of such 6% Non-Voting Cumulative Preferred Stock not necessary to effect the exchange for such outstanding 7% and 8% Cumulative Preferred Stock of the*1282 corporation; and
BE IT AND THE SAME IS HEREBY FURTHER RESOLVED by the Stockholders of the corporation that if, as and when such charter amendment shall have been filed and accepted by the Secretary of State of the State of Texas and all of such 8% and 7% Preferred stock shall have either been exchanged or redeemed, as hereinbefore provided, the directors shall be and they are hereby authorized and directed to cause another charter amendment to be filed reducing the capital stock of the corporation by the elmination of such 8% and 7% Preferred Stock.
Under date of May 19, 1937, a letter was addressed to each of the 8 percent and 7 percent preferred stockholders, advising them of the action taken at the meeting and informing them that they had a right to receive new shares of 6 percent preferred stock in exchange for their 8 percent and 7 percent preferred stock, and also the right to receive new shares of 6 percent preferred stock to the extent of full shares for the premiums to which they were entitled; or that if they wished they could receive the full amount of the premiums in cash. They were further advised that if the stockholders failed to make an election their shares would*1283 be called and redeemed in cash. Pursuant to such notification holders of 3,671 shares elected to receive new shares of 6 percent preferred stock, share for share, and as many premium shares as they were entitled to receive. Under their election they received 3,865 shares of new 6 percent preferred stock and $1,090 cash. The holders of 896 shares elected to receive 896 preferred shares and their premiums in cash ($5,210). The holders of 234 shares failed to make any election and their shares of stock were redeemed at a price of $23,400 for par value and $1,480 for premiums.
The total cash payment of $7,780 was charged against the petitioner's earned surplus, as were also the 194 premium shares of a par value of $19,400.
*804 The market value of the newly issued 6 percent cumulative preferred stock as of the date of issue and exchange was par. All of these exchanges and the retirements by cash occurred during the year 1937.
In its income tax return for 1937 the petitioner claimed the amount of $191,581.72 as a dividends paid credit and deducted this amount from its adjusted net income for the purpose of computing the surtax on undistributed profits. The total value*1284 of the premiums in stock and cash included in the $191,581.72, mentioned above, consisted of:
| Stock | $19,400 |
| Cash | 7,780 |
| Total | 27,180 |
OPINION.
SMITH: The first question for decision is whether the petitioner is entitled to deduct from gross income $20,413.80 invested in the Keedoozle contracts. The petitioner contends that the loss was sustained in 1937, since in that year Clarence Saunders, acting for the Keedoozle Corporation, had practically acknowledged the worthlessness of the Keedoozle system by its abandonment. It therefore charged off its investment as a loss in 1937.
The respondent contends that the loss was not sustained in 1937 by reason of the fact that in 1938 Saunders continued his efforts to make the electrically operated system a success and that during 1938, 1939, and 1940 the petitioner had made requests upon the Keedoozle Corporation for it to furnish the equipment which was called for by the contracts.
The question of when a loss is sustained is a question of fact, to be determined in the light of all the circumstances of the case. This Board and the courts have many times held that a taxpayer may not, in the light of known facts, *1285 refuse to recognize a loss in one year and claim it in a subsequent year. If there is an identifiable event fixing a loss in one year it may not be claimed in a later year.
The petitioner contends that the identifiable event in the proceeding at bar was the practical acknowledgment by Saunders that the Keedoozle system was a failure in 1937. That is shown by the fact that he abandoned that system after it had been tried out in a store in Memphis. Admittedly it was in an experimental stage in 1937. We think, in the light of all of the facts in this case, that the loss was sustained in 1937. The respondent's action in disallowing the deduction of the loss is reversed.
The second question in issue is whether the petitioner is entitled to include in its dividends paid credit the amount of $27,180 which represents the premiums paid in cash or, to the extent of $19,400, in *805 an issue of 6 percent cumulative preferred stock of the petitioner in connection with the transaction involving the retirement of its 8 percent and 7 percent preferred stock.
Section 27 of the Revenue Act of 1936, under the heading "Corporation Credit for Dividends Paid" provides:
(a) DIVIDENDS*1286 PAID CREDIT IN GENERAL. - For the purposes of this titie, the dividends paid credit shall be the amount of dividends paid during the taxable year.
* * *
(e) TAXABLE STOCK DIVIDENDS. - In case of a stock dividend or stock right which is a taxable dividend in the hands of shareholders under section 115(f), the dividends paid credit with respect thereto shall be the fair market value of the stock or the stock right at the time of the payment.
(f) DISTRIBUTIONS IN LIQUIDATION. - In the case of amounts distributed in liquidation the part of such distribution which is properly chargeable to the earnings or profits accumulated after February 28, 1913, shall, for the purpose of computing the dividends paid credit under this section, be treated as a taxable dividend paid.
* * *
(h) NONTAXABLE DISTRIBUTIONS. - If any part of a distribution (including stock dividends and stock rights) is not a taxable dividend in the hands of such of the shareholders as are subject to taxation under this title for the period in which the distribution is made, no dividends paid credit shall be allowed with respect to such part.
Section 112, under the caption "Recognition of Gain or Loss" provides*1287 in material part as follows:
(b) EXCHANGES SOLELY IN KIND. -
* * *
(2) STOCK FOR STOCK OF SAME CORPORATION. - No gain or loss shall be recognized if common stock in a corporation is exchanged solely for common stock in the same corporation, or if preferred stock in a corporation is exchanged solely for preferred stock in the same corporation.
(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.
* * *
(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) 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 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.
*1288 (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 the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed *806 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.
* * *
(g) DEFINITION OF REORGANIZATION. - As used in this section and section 113 -
(1) The term "reorganization" means * * * (D) a recapitalization * * *.
Section 115, so far as material, provides:
SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(a) DEFINITION OF DIVIDEND. - The term "dividend" when used in this title (except in section 203(a)(3) and section 207(c)(1), relating to insurance companies) means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings*1289 or profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.
* * *
(c) DISTRIBUTION IN LIQUIDATION. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. * * *
* * *
(f) STOCK DIVIDENDS.
(1) GENERAL RULE. - A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution.
(2) ELECTION OF SHAREHOLDERS AS TO MEDIUM OF PAYMENT. - Whenever a distribution by a corporation is, at the election of any of the*1290 shareholders (whether exercised before or after the declaration thereof), payable either (A) in its stock or in rights to acquire its stock, of a class which if distributed without election would be exempt from tax under paragraph (1), or (B) in money or any other property (including its stock or in rights to acquire its stock, of a class which if distributed without election would not be exempt from tax under paragraph (1)), then the distribution shall constitute a taxable dividend in the hands of all shareholders, regardless of the medium in which paid.
(g) REDEMPTION OF STOCK. - If a corporation cancels or redeems its stock (whether of not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.
Admittedly all of the $27,180 in premiums called for by the outstanding 8 percent and 7 percent preferred*1291 stock was charged against *807 earned surplus, both those paid in cash ($7,780) and in 6 percent preferred stock ($19,400). The petitioner submits:
* * * Since all outstanding shares of each of the three issues (8% voting stock, 8% non-voting stock, and 7% non-voting stock) were redeemed and retired, the distribution in connection therewith was a distribution in liquidation within the meaning of subsection (f) of Section 27 of the Act. And since the amount of such distribution which applied against or covered the premium on the liquidated stock was properly chargeable (and was in fact charged) to earnings and profits accumulated since February 28, 1913, that amount must under subsection (f), and for the purpose of computing the dividends paid credit, be treated as a taxable dividend paid.
It further submits that the Board in Colorado Life Co.,29 B.T.A. 950, held that premiums paid on redemption of stock, pursuant to previous agreement, constituted a dividend, which was taxable to recipients.
The respondent, on the other hand, submits that the transactions presently under consideration amounted merely to a recapitalization of the petitioner's capital*1292 structure, cognizable as a reorganization under the applicable provisions of the Revenue Act of 1936; that the recipients of the 194 shares of petitioner's 6 percent preferred stock in payment of part of the premiums due them upon the redemption of their shares were not liable to income tax for 1937 upon their fair market value under section 112(b) and (c) of the act. He cites in support of the latter proposition Skenandoa Rayon Corporation,42 B.T.A. 1287 (now pending on appeal before the United States Circuit Court of Appeals for the Second Circuit). The facts in that case were that the taxpayer corporation had outstanding shares of 7 percent cumulative preferred stock on which there were unpaid dividends of $45.50 per share. Upon a recapitalization of the corporation each of the shareholders was entitled to receive and did receive 1.4 shares of new preferred stock plus $5.50 cash. In his determination of the deficiency the respondent allowed a dividends paid credit in respect of the cash paid but refused to allow a dividends paid credit in respect of the excess number of shares of the new preferred stock issued in exchange for the old. We held that the taxpayer*1293 was not entitled to a dividends paid credit in respect of those excess shares. Compare South Atlantic Steamship Line,42 B.T.A. 705, in which the Board held:
In the course of readjustment of the capital structure of a corporation petitioner exchanged preferred stock upon which dividends were in arrears for new stock, bonds, and cash. Held, that receipt of the new stock was neither a dividend nor essentially equivalent to a dividend under section 115(a) and 115(g) of the Revenue Act of 1936; held, further, that the stock, debenture bonds, and cash were received by petitioner in the course of a reorganization and gain is recognized under section 112(c)(1) only to the extent of the cash received.
*808 The petitioner submits that the situation presented by the instant proceeding is different from the situations in the last two cited cases for the reason that the 8 percent and 7 percent preferred stockholders were given an option to receive either new shares of 6 percent preferred stock for their old stock or cash. It submits that, since they could have received cash had they so elected, the receipt of the cash and new shares in payment of their premiums*1294 makes the distribution of the $27,180 in question taxable dividends of the recipients. It relies upon section 115(f). That section relates to "Stock Dividends." We are of the opinion that it is not applicable to this case. Clearly the corporation did not declare a stock dividend.
Although nothing is said in the resolution adopted by the stockholders of the corporation relative to a "recapitalization" of its capital structure, cf. Skenandoa Rayon Corporation, supra, we think it must be held that there was a recapitalization of the corporation within the meaning of the reorganization provisions of the Revenue Act of 1936 - at least to the extent that the holders of 4,567 shares of the 8 percent and 7 percent preferred stock exchanged them for 4,761 shares of the new 6 percent preferred stock and $6,300 cash. At the time the resolution was adopted it was known that many of the 8 percent and 7 percent preferred stockholders would accept the 6 percent stock in exchange for their stock. The directors were instructed to obtain an amendment of the corporation's charter whereby the corporation would be permitted to issue 6,000 additional shares of 6 percent preferred*1295 stock to carry the plan into effect. Such plan constituted a recapitalization, and, hence, a reorganization within the meaning of the statute.
We think it plan that if all of the 8 percent and 7 percent preferred stockholders had accepted the plan and had received nothing but 6 percent preferred shares in exchange for their shares, the stockholders would not have been liable to any income tax on the gain under section 112(b)(3) of the statute. Section 112(c)(1) provides that if something besides stock is received upon a reorganization the recipients shall be taxable upon the gain "but in an amount not in excess of the sum of such money and the fair market value of such other property." Except for the cash in the amount of $6,300 received upon the exchange for the 4,567 shares, no other property was received. The recipients of the $6,300 cash are liable to income tax upon that amount of money and no more. See South Atlantic Steamship Line, supra.
Section 112(c)(2) provides in part:
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*1296 dividend, then there shall be taxed as a dividend to each distributee such an amount of the gain recognized under paragraph (1) *809 as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. * * *
The above quoted language appeared first in section 203(d)(2) of the Revenue Act of 1924. In the Ways and Means Committee Report (68th Cong., 1st sess., H. Rept. 179) is this statement:
* * * 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, *1297 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. * * *
We think, therefore, that the $6,300 paid out by the corporation and charged to its earned surplus in connection with the exchange of the 4,567 shares was a taxable dividend of the petitioner corporation and the petitioner is entitled to a dividends paid credit in respect of that amount.
The respondent submits that the evidence does not show whether the recipients of the $6,300 in cash are taxable thereon, since the cost of the shares to the several*1298 stockholders is not shown. The evidence does show, however, that the shares were issued by the petitioner corporation at par either for cash or for property of a value equal to par. This issue relative to the disallowance of the claimed dividends paid credit in the amount of $27,180 was raised by the respondent by an amendment to his answer. The burden of proof of showing that the stockholders were not taxable upon the $6,300 is upon the respondent. Since the respondent has not borne that burden it must be held that the $6,300 constitutes a taxable dividend of the recipients thereof.
We think that it may logically be said that the reclassification of the petitioner's capital structure relates only to the 4,567 shares of 8 percent and 7 percent preferred stock referred to above. The remaining 234 shares of that stock were redeemed in cash. That transaction constituted a liquidating distribution. The cash paid in *810 connection therewith was $1,480, which was likewise charged against earned surplus. Petitioner is entitled to a dividends paid credit in respect of that amount under section 27(f) of the statute.
We thus reach the conclusion that petitioner is entitled*1299 to a dividends paid credit in the amount of $7,780, but not to a dividends paid credit in the claimed amount of $19,400, representing the portion of the premium paid by the issuance of 194 shares of the 6 percent preferred stock.
Reviewed by the Board.
Decision will be entered under Rule 50.