*648 1. In the recapitalization of a corporation in 1923 the petitioner received 125,000 shares of class A stock and 250,000 shares of new no par common stock in exchange for 100,000 shares of old no par common stock, and later in 1923 sold the 125,000 shares of class A and 20,000 shares of the new no par common stock for $2,250,000 cash. Held, that the basis for computing gain or loss on the sale is the cost of the 100,000 shares of old no par common stock properly apportioned to the shares sold.
2. The petitioner had in his employ E. F. von Wettberg. Beginning in 1913, the petitioner advanced funds to von Wettberg for the purpose of marketing tire chains and other autombile accessories through hardware stores. In 1914 the business was incorporated with a capital stock of $25,000, consisting of 250 shares of $100 par value each. The stock was issued in the name of von Wettberg and others who immediately endorsed the certificates in blank and turned them over to the petitioner. The petitioner continued to advance funds to von Wettberg to be used in the business. The net amount of his advances to von Wettberg up to the close of 1923 was $441,339.48. The company was liquidated*649 in 1923 and $87.50 was paid to the petitioner in full settlement of his advances. Held, that the loss sustained upon the liquidation in the amount of $441,251.98 was not a capital net loss.
*768 Petitioner seeks a redetermination of a deficiency of $174,403.33 in income tax for the calendar year 1923. A number of errors are alleged in the petition and the amendments thereto, but all have been abandoned except two, which are (1) that the respondent erred in holding that the petitioner realized a capital net gain of $2,247,094.80 when he exchanged 100,000 shares of no par common stock of the American Chain Co. in a recapitalization of that company for 125,000 shares of class A stock and 250,000 shares of no par common stock of the company; and (2) failure of the respondent to allow petitioner a capital loss of $441,251.98 upon the liquidation of a corporation known as E. F. von Wettberg, Inc.
FINDINGS OF FACT.
The petitioner is a resident of Fairfleld, Connecticut. During 1923*650 he was president and principal stockholder of the American Chain Co.
*769 In 1905, when the petitioner was connected with the Bridgeport Chain Co., he observed that one Harry D. Weed was purchasing large quantities of chain. Upon investigation he found that Weed was using the chain in the manufacture of tire chains for use on motor vehicle wheels to prevent skidding and slipping, and that Weed owned a patent on his invention. Realizing that the patent was valuable, petitioner acquired the exclusive rights to manufacture under it and on December 20, 1905, organized the Weed Chain Tire Grip Co., to which he assigned the license, and became its sole stockholder. The company operated under the license and paid royalties to the patentee, Weed, until 1910 or 1911, when petitioner in his individual capacity purchased the Weed patent outright. From that time until January 3, 1916, the Weed Chain Tire Grip Co. paid royalties to the petitioner. The company also acquired the exclusive license to manufacture and sell under a patent known as the Parsons patent and paid royalties to Parsons.
The Parsons patent was issued March 24, 1903, as Patent No. 723299 and its expiration date*651 was March 24, 1920. The Weed patent was issued August 23, 1903, as Patent No. 768495 and its expiration date was August 23, 1920.
The Parsons patent was the basic patent on the "creeping principle" in a tire chain. The Weed patent embodied the basic idea of a practical application of that principle. The basic idea of "creeping" resided in the Parsons patent but the basic idea of a practical creeping chain resided in the Weed patent. The Weed tire chain was thus manufactured under the protection of the two patents.
Other manufacturers attempted to manufacture tire chains using the principles covered by the Weed patent, but infringement suits were instituted against such manufactrers with the result that the Weed Chain Tire Grip Co. was sustained in every particular. The Weed Chain Tire Grip Co. had a practical monopoly on the manufacture of automobile tire chains from 1911.
In 1912 the American Chain Co. was organized for the purpose of making the chain used by the Weed Chain Tire Grip Co. All of the common stock of the company, consisting of 5,000 shares, was owned by the Weed Chain Tire Grip Co.
In 1915 the petitioner was the owner of all the shares of stock of the*652 Weed Chain Tire Grip Co. It was paying royalties to the owner of the Parsons patent and also to the petitioner, the owner of the Weed patent. The petitioner received royalties on his Weed patent as follows:
| 1913 | $78,945.38 |
| 1914 | 101,821.75 |
| 1915 | 224,943.53 |
*770 The net earnings of the Weed Chain Tire Grip Co., after the payment of royalties for the calendar years 1913, 1914, and 1915, were as follows:
| 1913 | $501,385.52 |
| 1914 | 711,361.83 |
| 1915 | 1,077,181.25 |
The net worth of the assets of the Weed Chain Tire Grip Co., as shown by its books of account, was as follows:
| January 1, 1913 | $292,486.19 |
| January 1, 1914 | 780,686.76 |
| January 1, 1915 | 1,317,738.28 |
In December 1915 the petitioner made a proposal to the directors of the Weed Chain Tire Grip Co. to purchase all of the assets of that company at the book value shown by an audit on December 31, 1915. This proposal was accepted. Pursuant thereto, the petitioner acquired from the Weed Chain Tire Grip Co., on December 31, 1915, the 5,000 shares of American Chain Co. stock owned by that company and paid therefor $125,000. The journal entry recording this transaction states: *653 "Book value of 5,000 shares of common stock of above Co. sold to him [Walter B. Lashar] with other assets as per Directors minute Dec. 9th, 1915." As of December 31, 1915, the authorized capital stock of the American Chain Co. was increased from 5,000 shares of common stock to 10,000 shares of a par value of $100 per share and provision was made for the issuance of 20,000 shares of preferred stock of the same par value. On the same date, the petitioner acquired from the Weed Chain Tire Grip Co. all of its assets and assumed all of its liabilities. As shown by the journal of the Weed Chain Tire Grip Co., the petitioner on December 31, 1915, was debited $1,635,419.69 "For the assets of the Company at December 31, 1915, purchased by W. B. Lashar as of that date." He was also given credit on the same date for $57,368.07 "To Liabilties and reserves for accrued liabilities to be applied in reduction of assets charged to W. B. Lashar in former entry." He also received cash from the company in the amount of $135,170.36. The net price paid for these assets was therefore $1,713,221.98. On the next business day, January 3, 1916, the petitioner transferred to the American Chain Co. the net*654 assets received from the Weed Chain Tire Grip Co., exclusive of the 5,000 shares of American Chain Co. stock, of a book value of $1,713,221.98 less $34,964.86, or of a recorded book value of $1,678,257.12 plus $10,000, representing the then value of all of the shares of stock of the Weed Chain Tire Grip Co., plus $811,742.88 for good will, or a total of $2,500,000 for 5,000 additional shares of common and 20,000 shares of preferred stock of the American Chain Co. At the same time, and as a part of the consideration *771 for the issuance to him of these additional shares, the petitioner transferred the Weed patent to the American Chain Co.
During the first six or seven months of 1916 the petitioner sold approximately a third of his holdings of the preferred stock of the American Chain Co. at par and between 1916 and 1920 he sold the balance of it, also at par. Through these sales the petitioner admits that he recovered $2,000,000 of the cost of his shareholdings in the American Chain Co.
On July 9, 1920, the common stock of the American Chain Co. was changed from 10,000 shares of a par value of $100 each to 100,000 shares of no par value. As a result of this recapitalization*655 the petitioner received 100,000 shares of no par value stock in exchange for his 10,000 shares of stock of a par value of $100 per share.
In 1923 the American Chain Co. had outstanding the following shares of stock:
100,000 no par value common shares, all owned by the petitioner.
7% cumulative preferred stock of a par value of $4,648,000.
Class A 7% cumulative and 3% noncumulative, if earned, of a par value of $2,720,000.
Class B 7% cumulative and 3% noncumulative, if earned, of a par value of $540,500.
On February 28, 1923, the petitioner addressed a letter to Dillon, Read & Co. and Hemphill, Noyes & Co., bankers of New York City, which stated in material part as follows:
American Chain Company, Inc., is a New York corporation, whose balance sheet as of December 31, 1922, is attached hereto and marked Schedule "A", and whose statement of annual profits for the years 1916 to 1922, inclusive, are set forth in Schedule "B" hereto attached and made part hereof, and which said Schedules are represented by me to be in all respects correct.
In the event that you accept this offer, I will organize or cause to be organized, under the laws of the State of New York, or*656 such other State as you approve, a new company to be designated by the name of "American Chain Company, Inc.", or such other name as may be designated by you, which said new company is hereinafter referred to as the "New Company".
The Company will acquire all the property, assets and business of the American Chain Company, Inc. (hereinafter called the "Existing Company"), and the authorized capitalization of the New Company will be as follows:
| Authorized Presently to be issued | |
| Capitalization - 10 Year 6% Debentures | $7,500,000 |
| Class A Stock 500,000 shs. 350,000 shs. | |
| $25 per share | |
| 8,750,000 | |
| Common Stock 357,143 shs. 250,000 shs. | |
| No par value |
I will cause the Existing Company to call for redemption on the first day of April, 1923, all its outstanding Preferred Stock, all its outstanding Class A Stock and all its outstanding Class B Stock, and will cause the Existing Company to deposit on or before April 2, 1923, the cash required for such call, so *772 that after such deposit and call there will be outstanding on said date only 100,000 shares of Common Stock of the Existing Company, all of which are and will then be owned and controlled by me.
*657 I will cause the Existing Company to sell the New Company all its good will, patents and patent rights, fixed and other assets, except cash and surplus upon the issue and delivery and payment therefor by the New Company to the Existing Company of $7,500,000 of the Debentures of the New Company above referred to and hereinafter more particularly described, 350,000 shares of Class A Stock of the par value of $25 per share, hereinafter more particularly described, and 250,000 shares of Common Stock of the New Company without par value, hereinafter more particularly described, and will cause the Existing Company to pay, transier, sell and set over to the New Company all its cash on hand as of April 2, 1923, and all its surplus as of that date, in consideration of the assumption by the New Company of the payment of all the liabilities and obligations of the Existing Company and the agreement of the New Company to hold and save harmless the directors and stockholders of the Existing Company and indemnify them from any liability in respect of the debts and/or obligations of the Existing Company. Such cash to be paid over to the New Company as aforesaid shall include any balance remaining*658 in the treasury of the Existing Company after the sale or other disposition of the aforesaid Debentures, Class A Stock and Common Stock of the New Company and the retirement of the Preferred Stock, Class A Stock and Class B Stock of the Existing Company.
In connection with or at the time of the transfer of the aforesaid assets cash and surplus of the New Company, I will cause the Existing Company to deliver to the New Company 100,000 shares of Common Stock of the Existing Company, with no par value, which will be all the issued capital stock of the Existing Company, so that the Existing Company may be dissolved and liquidated by the New Company.
Upon receipt by the Existing Company of the aforesaid $7,500,000 of said Debentures, said 350,000 shares of Class A Stock and said 250,000 shares of Common Stock of the New Company I will cause the Existing Company to sell and deliver to you $7,500,000 of said Debentures at the price of 92 1/2% of the principal amount thereof and accrued interest on such principal amount from the date of the Debentures to date of delivery and to sell and deliver to you 250,000 shares of said Class A Stock, fully paid and non-assessable, at the price of*659 $22.50 per share and accrued dividends from April 1, 1923. I will also cause the Existing Company to sell and deliver to me 100,000 shares of said Class A Stock and 250,000 shares of said Common Stock of the New Company upon my surrender and delivery to the Existing Company of all the outstanding stock of the Existing Company, which will then be 100,000 shares of Common Stock of no par value, the Preferred Stock, Class A Stock and Class B Stock of the Existing Company beign retired through proceeds of the sale of the aforesaid Debentures and Class A Stock of the New Company.
I will then sell to you 100,000 shares of said Class A Stock received by me and 20,000 shares of said Common Stock received by me for a total price of $2,250,000. All of said securities aforesaid to be delivered to you by the Existing Company and all of said stock to be delivered to you by me as aforesaid shall be delivered on April 2, 1923, at the office of Dillon, Read & Co., or as hereinafter rpovided.
The proposal made by the petitioner was accepted by the bankers under date of February 28, 1923.
*773 The agreement, however, was not carried out strictly in accordance with its terms. No new*660 corporation was organized, but instead the existing corporation amended its charter to provide for the issuance of 500,000 shares of class A stock of a par value of $25 per share and 357,143 shares of common stock of no par value. By a further amendment to the agreement the company sold to Dillon, Read & Co. and Hemphill, Noyes & Co. 225,000 shares of class A stock at $25 per share instead of 250,000 shares of such stock at $22.50 per share. The agreement, with these changes, was unanimously approved by the directors at a meeting held March 28, 1923, and by the stockholders at a meeting subsequently held. Pursuant to the amended agreement the reorganization of the company was carried out and the company sold to Dillon, Read & Co. and Hemphill, Noyes & Co. 225,000 shares of class A stock at $25 per share and $7,500,000 par value of 6 percent debenture bonds at 92 1/2, with accrued interest, and issued to the petitioner 125,000 shares of class A stock and 250,000 common no par value stock in exchange for his 100,000 shares.
Thereafter the petitioner on April 2, 1923, under further amendment to the above agreement of February 28, 1923, sold to the bankers 125,000 shares of class*661 A stock instead of 100,000 shares of class A stock, as originally agreed upon, and 20,000 shares of no par value common stock, for $2,250,000. The consideration of $2,250,000 was paid to petitioner in cash by Dillon, Read & Co. and Hemphill, Noyes & Co., jointly.
In connection with this sale of stock to Dillon, Read & Co. and Hemphill, Noyes & Co. the petitioner incurred expenses of $2,050.20 for transfer stamps, $5,514.22 for attorney fees, and $1,425 for accounting fees, making a total of $8,989.42.
The fair market value of the American Chain Co. class A stock on April 2, 1923, was $25.50 per share. The fair market value of the no par value common stock was $5 per share.
In making his income tax return for 1923 the petitioner computed the capital gain from the receipt of the $2,250,000 cash in the following manner: He reported that the expenses connected with the sale of 125,000 shares class A stock and 20,000 shares common stock amounted to $9,844.42; that the cost to him of the shares sold was $1,000,000; and that he had realized a capital gain from the sale of $1,240,155.58.
The respondent, in the determination of the deficiency, valued the common stock received, *662 230,000 shares, at $25 per share, making $5,750,000, added cash of $2,250,000, making a total of $8,000,000 received, and subtracted therefrom a cost of $1,000,000, plus stamps $2,905.20, or a total cost of $1,002,905.20, showing a profit of $6,997,094.80. The transaction was considered by the respondent as falling *774 under section 202(e) of the Revenue Act of 1921, so that the taxable profit on the transaction was $2,247,094.80, the amount of the cash received less cost of stamps.
The cost to the petitioner of the 100,000 shares of no par value common stock of the American Chain Co. exchanged by him on April 2, 1923, for 125,000 shares class A stock and 250,000 shares common stock was $1,000,000. The fair market value of the class A stock and common stock at the date of receipt was $25.50 and $5 per share, respectively.
In 1913 the petitioner decided to try to further the sales of automobile accessories, particularly tire chains, through the acquisition of a chain of hardware stores. For business reasons he did not desire to have his name connected with the undertaking and so had it inaugurated as an unincorporated venture, acting through and in the name of an agent, *663 an employee of his, by name of E. F. von Wettberg. During 1913 the petitioner advanced cash and merchandise to this venture in the amount of $34,000 and during 1914 in the amount of $15,450. In June 1914 the venture was incorporated as E. F. von Wettberg, Inc. All of the stock was issued to E. F. von Wettberg and three other nominees who held qualifying shares. The total stock issue was 250 shares of the par value of $100 each. When the stock had been issued to von Wettberg and the three qualifying shareholders they in turn endorsed the certificates in blank and delivered them to the petitioner. Neither von Wettberg nor any of the three qualifying shareholders contributed anything whatsoever to the corporation and none of them was ever the beneficial owner of any stock therein. E. F. von Wettberg acted as the agent of the petitioner in the organization and management of this corporation. After the business was incorporated the petitioner continued to make advances to it. The net amount of his advances from 1913 through 1923 was $441,339.48. His advances in 1922 and 1923 were $14,468.10 and $4,000, respectively. In the assets and liabilities accounts of the corporation these*664 advances were not shown as amounts payable to the petitioner, but as liabilities of the corporation to E. F. von Wettberg, with the exception of $25,000 for which the shares of capital stock had been issued. In making statements to the bank as to its financial condition, the company never showed the advances made by the petitioner as an outstanding liability either to the petitioner or to von Wettberg. The balance sheet at December 31, 1922, showed an excess of liabilities (including advances made by the petitioner) over assets in the amount of $210,998.86. In 1923 it was decided to liquidate the corporation. Upon the final wind-up of the business there was a balance remaining of $87.50, which was paid over to the petitioner in full settlement *775 of his advances to the enterprise. The petitioner's total loss in the enterprise was $441,251.98. In the computation of the deficiency the respondent has allowed the deduction of $441,251.98 as an ordinary loss, but not as a capital net loss. The amount was not a capital net loss.
OPINION.
SMITH: It is the contention of the respondent relative to the principal issue that, even though several steps were taked in the recapitalization*665 of the American Chain Co., each step was a part of a general plan of reorganization and that the petitioner really exchanged his 100,000 shares of old no par value common stock of that company which had a cost basis of $1,000,000 for 230,000 shares of new no par value common stock of a fair market value of $25 per share and $2,250,000 cash, and that he is taxable under section 202(e) of the Revenue Act of 1921, as amended by the Act of March 4, 1923, to the extent of the cash received. The petitioner contends that he exchanged his 100,000 shares of old no par common stock for 125,000 shares class A stock and 250,000 shares of new no par common stock pursuant to a reorganization; that as a separate transaction he sold the class A stock and 20,000 shares of new no par common stock to the bankers for $2,250,000; that the cost of the shares sold was in excess of $2,250,000 and that he therefore sustained a deductible loss on the transaction.
The material provisions of section 202 of the Revenue Act of 1921, as amended by the Act of March 4, 1923, are as follows:
BASIS FOR DETERMINING GAIN OR LOSS
SEC. 202. (a) That the basis for ascertaining the gain derived or loss sustained from*666 a sale or other disposition of property, real, personal, or mixed, acquired after February 28, 1913, shall be the cost of such property; except that -
* * *
(c) For the purpose of this title, on an exchange of property, real, personal or mixed, for any other such property, no gain or loss shall be recognized unless the property received in exchange has a readily realizable market value; but even if the property received in exchange has a readily realizable market value, no gain or loss shall be recognized -
* * *
(2) When in the reorganization of one more corporations a person receives in place of any stock or securities owned by him, stock or securities in a corporation a party to or resulting from such reorganization. The word "reorganization," as used in this paragraph, includes a merger or consolidation (including the acquisition by one corporation of at least a merger 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 of substantially all the properties *776 of another corporation), recapitalization, or mere change in identity, form, or place of organization of a corporation (however*667 effected); or
* * *
(d) (1) Where property is exchanged for other property and no gain or loss is recognized under the provisions of subdivision (c), the property received shall, for the purposes of this section, be treated as taking the place of the property exchanged therefor, except as provided in subdivision (e);
* * *
(e) Where property is exchanged for other property which has no readily realizable market value, together with money or other property which has a readily realizable market value, then the money or the fair market value of the property having such readily realizable market value received in exchange shall be applied against and reduce the basis, provided in this section, of the property exchanged, and if in excess of such basis shall be taxable to the extent of the excess; but when property is exchanged for property specified in paragraphs (1), (2), and (3) of subdivision (c) as received in exchange, together with money or other property of a readily realizable market value other than that specified in such paragraphs, the amount of the gain resulting from such exchange shall be computed in accordance with subdivisions (a) and (b) of this section, but in*668 no such case shall the taxable gain exceed the amount of the money and the fair market value of such other property received in exchange.
Our first question is whether the sale by the petitioner of the 125,000 shares of class A stock and the 20,000 shares of common stock to the bankers for $2,250,000 occurred in the reorganization of the American Chain Co. so that the petitioner's gain is to be computed under section 202(e) above, or whether such sale was a separate transaction, independent of the reorganization, on which the petitioner's gain or loss is to be computed on the basis of the cost of the shares sold.
The parties are in agreement that there was a statutory reorganization of the American Chain Co., as unquestionably there was under section 202(c)(2) above, brought about by the recapitalization of that company. The exchange by the petitioner of his old shares for new shares pursuant to this reorganization was a nontaxable exchange.
We agree with the petitioner's contention, however, that the sale by him to the bankers of the portion of the new shares of stock which he thus received was not an essential part of and was not within the reorganization. The reorganization*669 was embodied in the "recapitalization" of the company. This was completed before the sale by the petitioner of any of the stock which he acquired in the reorganization. It is true that the provision for the sale was incorporated in the original agreement made by the petitioner and the bankers, as later amended, but the company itself was not a party to the agreement and the company's reorganization was not conditioned upon it. In his offer to the bankers the petitioner, after setting *777 out the details of the proposed reorganization, stated "I will then sell to you 100,000 shares of said Class A stock received by me and 20,000 shares of said common stock received by me for a total price of $2,250,000 * * *. All of said stock to be delivered to you by me as aforesaid shall be delivered on April 2, 1923 at the office of Dillon, Reed & Company or as hereinafter provided." (Italics ours.)
The petitioner and the bankers were entirely at liberty after completion of the reorganization to alter or revoke this part of the agreement, and in fact did alter it as to the number of shares which the petitioner should sell.
*670 We have held in a number of cases that not every transaction which takes place as a consequence of a reorganization or which is provided for in an agreement embodying a plan of reorganization is to be treated for tax purposes as a part of a statutory reorganization. It is only those transactions which form an essential part of the reorganization that are to be so treated. See Daisy M. Ward,29 B.T.A. 1251">29 B.T.A. 1251; affd., 79 Fed.(2d) 381; Ballwood Co.,30 B.T.A. 644">30 B.T.A. 644 (reversed on a question of reorganization on the authority of Helvering v. Watts,296 U.S. 387">296 U.S. 387; Edison Securities Corp.,29 B.T.A. 483">29 B.T.A. 483 (remanded to the Board, 78 Fed.(2d) 85); Liquidating Co.,33 B.T.A. 1173">33 B.T.A. 1173; Swiss Oil Corporation,32 B.T.A. 777">32 B.T.A. 777.
Under the provisions of section 202 (d)(1) above the 125,000 shares of class A stock and the 250,000 shares of common stock received by the petitioner in the reorganization in exchange for his 100,000 shares of old common stock are to "be treated as taking the place of the property exchanged therefor."
Our question, then, is, What was the cost to the petitioner*671 of the 100,000 shares of old common stock?
In his income tax return for the year involved the petitioner used a cost basis for the 100,000 shares of $1,000,000. The same cost basis was used by the respondent in his determination of the deficiency. The petitioner now contends, however, that the cost basis was much greater than that amount.
The evidence shows that the 100,000 shares no par common stock in question were acquired by the petitioner on July 9, 1920, as the result of a nontaxable reorganization of the American Chain Co. on that date. These were acquired in exchange for all of the common stock of the American Chain Co. then outstanding, viz., 10,000 shares, par value $100 each, all of which was owned by the petitioner. The transaction which took place on July 9, 1920, was simply a split-up of the common shares, ten for one. Since the split-up was admittedly a nontaxable reorganization under the statute, the 100,000 shares of *778 no par common stock had the same cost basis as the 10,000 shares of $100 par common stock. Our problem, then, is to determine the cost basis to the petitioner of those shares.
This takes us back to December 31, 1915. On that*672 date the petitioner purchased from the Weed Chain Tire Grip Co. 5,000 common shares of the American Chain Co. for $125,000. On the same date he purchased all of the other assets of the Weed Chain Tire Grip Co., at a net price of $1,713,221.98. On the next business day, January 3, 1916, but as of December 31, 1915, he turned over those assets, less $34,964.86, or of a book value of $1,678,257.12 plus $10,000 for the outstanding stock of the Weed Chain Tire Grip Co., plus $811,742.88 shown on the journal of the Weed Chain Tire Grip Co. as "good will" for $2,500,000 par value of stock of the American Chain Co. divided into 5,000 common shares and 20,000 preferred shares, each of a par value of $100.
On brief, the petitioner admits that previous to the transaction here involved he recovered $2,000,000 of the cost basis through the sale of 20,000 shares of preferred stock of the American Chain Co.
The petitioner first contends that the cost to him of 5,000 shares of the American Chain Co. common stock purchased by him from the Weed Chain Tire Grip Co. on December 31, 1915, was not $125,000 as shown by the books of the Weed Chain Tire Grip Co. but was $777,901.38, representing the*673 par value of the 5,000 shares plus $277,901.38 surplus shown by the books of the American Chain Co. He next contends that the cost to him of the 5,000 additional shares of common stock and the 20,000 shares of preferred stock received by him from the American Chain Co. for the assets paid in by him on January 3, 1916, was much greater than $2,500,000. He contends that the earnings of the Weed Chain Tire Grip Co. for the years 1913, 1914, and 1915 establish a very large value for the assets and that the value of the Weed patent paid in amounted to several million dollars. This claim is predicated in large part upon the testimony of Hiram Percy Maxim, who testified that in his opinion the value of the Weed patent at the beginning of 1916 plus the value of the license rights which inhered in the Parsons license was at least $5,000,000.
Although there are cases which hold that under the Revenue Acts of 1913, 1916, and 1917 the cost of shares of stock is equal to the fair market value of assets paid in to a corporation in exchange for the shares, *674 John J. Radel Co.,5 B.T.A. 250">5 B.T.A. 250; Reliance Investment Co.,22 B.T.A. 1287">22 B.T.A. 1287; Volker v. United States (D.C.), 40 Fed.(2d) 697; Law v. McLaughlin (D.C.), 2 Fed.Supp. 601, we are of the opinion that those cases are not applicable to the facts here present.
*779 The evidence is clear that the only amount paid by the petitioner to the Weed Chain Tire Grip Co. for 5,000 shares of common stock of the American Chain Co. on December 31, 1915, was $125,000. The evidence is equally clear that the petitioner paid only $1,713,221.98 for the remaining net assets of the Weed Chain Tire Grip Co., on December 31, 1915, which included all of the other assets of the Weed Chain Tire Grip Co. except $10,000 cash retained for the purpose of meeting contingent income tax liabilities. These same assets of the net amount of $1,678,257.12 plus $10,000 for the stock of the Weed Chain Tire Grip Co. and $811,742.88 for good will plus the Weed patent individually owned by the petitioner from 1910 or 1911 were transferred by the petitioner to the American Chain Co. for the remaining 5,000 shares of common stock and 20,000 shares*675 of preferred stock of that company. The record contains no evidence as to the cost to the petitioner of the Weed patent acquired in 1910 or 1911 or as to its value on March 1, 1913. Apparently the Weed Chain Tire Grip Co. had an exclusive license to manufacture under this patent during its life. The license rights under the Weed patent and under the Parsons patent were obtained by the petitioner from the Weed Chain Tire Grip Co. on December 31, 1915, along with other assets for which the petitioner paid, as above stated, a net amount not exceeding $1,713,221.98.
The petitioner's income tax return for the taxable year involved and the respondent's determination of the deficiency are both based upon the premise that the cost of the petitioner's shareholdings in the American Chain Co. during 1916 and thereafter was $3,000,000; that the petitioner recovered $2,000,000 of that cost upon his sale of the preferred shares prior to 1920; and that the cost basis of the remaining 10,000 shares, exchanged in 1920 for the 100,000 shares of no par common stock and in 1923 exchanged for 125,000 shares of Class A stock and 250,000 shares of no par value common stock, was $1,000,000. We are*676 of the opinion that the evidence does not warrant a greater cost basis.
In point of fact it may be noted that $811,742.88 shown as good will on the American Chain Co.'s voucher record under date of January 4, 1916, is shown in the ledger of the American Chain Co. as the cost to that company of patents which included the Weed patent. So far as the record shows, the only value which the Weed patent had to the petitioner during the years 1913, 1914, and 1915 was the right to receive royalties from the Weed Chain Tire Grip Co. The evidence does not show that the fair market value of this right on January 3, 1916, was in excess of $811,742.88.
The next problem is to determine the portion of the cost basis of $1,000,000 allocable to the 125,000 class A shares and 20,000 no *780 par value common shares sold by the petitioner to the bankers in 1923 for $2,250,000 cash. The petitioner suggests that a proper allocation of the cost basis to those shares can be made upon the basis of their fair market value when received by the petitioner. We accept that suggestion. Cf. *677 Clifford Hemphill,25 B.T.A. 1351">25 B.T.A. 1351; Theodore W. Case et al., Trustees,26 B.T.A. 1044">26 B.T.A. 1044; Frances Elliott Clark,28 B.T.A. 1225">28 B.T.A. 1225. In Clifford Hemphill, supra, we ascertained the fair market value of the shares of each class of stock to be $25.50 per share for the class A stock and $5 per share for the common stock. Upon the evidence of record in this case we make the same determination.
Upon the basis of such allocation the gain or loss realized by the petitioner upon the sale of the 125,000 shares of class A and 20,000 shares of no par common stock for $2,250,000 is computed as follows:
| Formula based upon cost of $1,000,000 | |||||
| Class of stock | Shares received | Market value per share | Market value | Allocation percentage | Allocation of cost |
| Class A | 125,000 | $25.50 | $3,187,500 | 71.83% | $718,300 |
| Common | 250,000 | 5.00 | 1,250,000 | 28.17% | 281,700 |
| Total | 4,437,500 | 100.00% | 1,000,000 |
| Cost per share of common stock, $281,700 divided by 250,000 | $1.1268 | |
| Realized on sale of 125,000 class A and 20,000 shares common of American Chain Co | $2,250,000.00 | |
| Cost: | ||
| 125,000 shares class A (as above) | $718,300.00 | |
| 20,000 shares common at $1.1268 | 22,536.00 | |
| Transfer stamps, attorney's fees and accounting fees | 8,989.42 | 749,825.42 |
| Capital gain | 1,500,174.58 |
*678 The only other question which is before us in this proceeding is whether a loss of $441,251.98 sustained by the petitioner as a result of the liquidation of E. F. von Wettberg, Inc., was a capital net loss as the petitioner contends, or an ordinary loss as determined by the respondent.
The evidence is to the effect that the petitioner advanced various sums of moneys on open account to von Wettberg beginning in 1913. These advances continued into the year 1923 and amounted to a net aggregate of $441,339.48. It is the petitioner's contention that all of the amounts represented capital investments in E. F. von Wettberg, Inc.
*781 We are of the opinion that the evidence does not support the petitioner's contentions. The money was first advanced to von Wettberg and upon the organization of the corporation the shares of stock were issued to von Wettberg. The petitioner testified that these were endorsed in blank by von Wettberg and qualifying stockholders and turned over to the petitioner as "collateral." Granted that the petitioner had an investment in the shares of stock of the corporation, it is clear from the evidence that the shares of stock were utterly worthless*679 long prior to 1923. Ammounts advanced to the von Wettberg enterprise subsequent to the issuance of the shares of stock were advanced on open account. It certainly was clear to the petitioner long prior to 1923 that only a small portion, if any, of these advances would be repaid. The petitioner made the advances for the purpose of meeting operating deficits and for paying all claims against E. F. von Wettberg, Inc. The advances did not represent capital assets within the contemplation of the taxing statute. The disallowance of the claimed loss of $441,251.98 as a capital loss is approved.
Reviewed by the Board.
Judgment will be entered under Rule 50.
MURDOCK, dissenting: I think the reasoning of the prevailing opinion upon the first point is unsound in that it fails to consider the correct method of determining the basis to which the petitioner is entitled. The petitioner acquired 5,000 shares of $100 par common of the American Chain Co. for $125,000 by purchase on December 31, 1915. He acquired another 5,000 shares of the same stock, together with 20,000 shares of preferred, on January 3, 1916, by transferring certain property to the American*680 Chain Co. in exchange for the shares. The cost and basis for these shares was the fair market value of the property exchanged for them. That cost should be allocated between the common and preferred in proportion to the total fair market value of each received. The part allocated to the preferred is not used further in the present computation. The part allocated to the common, together with $125,000, the cost of the first 5,000 shares, forms the total basis of the 100,000 no par shares which the petitioner exchanged in 1923. It may be that the record does not show all of the values necessary to this computation. In that event the result reached in the prevailing opinion may be proper, because the Commissioner seems to concede that the basis of the 100,000 shares should be at least $1,000,000.
MELLOTT agrees with this dissent.