*53 Decision will be entered for the respondent.
Bondholders of a previous corporation, pursuant to a plan for organization of a new corporation and exchange of preferred stock for bonds, accepted therefor preferred stock in petitioner, the new corporation, in the amount of par value of the bonds, and interest, after the former corporation had been placed in receivership and its assets, securing the bonds, acquired by the petitioner subject to the lien of the bonds, from the trustee for the bondholders, the purchaser of the assets for a nominal amount at a foreclosure sale. Held, that, under section 718 (a) (2) of the Internal Revenue Code, petitioner's equity invested capital is an amount equal to the fair market value of the preferred stock exchanged for bonds, that being the cost of the assets to petitioner, plus liabilities of the former corporation assumed by the petitioner, and not the value of the property transferred to the petitioner by trustee for the bondholders. Depreciation on the property allowed accordingly.
*54 *657 This proceeding involves income, declared value excess profits, and excess profits taxes as follows:
| Declared | Excess | ||
| Year | Income tax | value excess | profits |
| profits tax | tax | ||
| 1942 | $ 6,144.43 | ||
| 1943 | $ 274.79 | $ 572.02 | 2,222.37 |
The issues raised by the pleadings and not waived at the hearing are whether the respondent erred in failing to include in petitioner's equity invested capital for each year the amount of $ 77,614.09 as the value of certain property transferred to petitioner as paid-in surplus or as a contribution to capital, and in disallowing certain amounts each year for depreciation. Stipulations of fact are incorporated herein by reference as part of our findings of fact.
FINDINGS OF FACT.
The Victory Glass Co., hereinafter sometimes referred to as the Glass Co., was a corporation organized under the laws of Pennsylvania in 1920. Upon organization it purchased a glass factory located in Jeannette, Pennsylvania, and thereafter engaged in the manufacture of glassware. The Glass Co. had $ 78,250 par value of stock outstanding from August 12, 1935, to April 1, 1937.
In 1924 the Glass Co. issued $ 40,000 of bonds to the Jeannette Savings*55 & Trust Co., Jeannette, Pennsylvania, as trustee. The bonds matured on July 1, 1934, and were secured by a first mortgage on the manufacturing plant of the Glass Co. Bonds of the face amount of $ 26,000, and accrued interest thereon of $ 5,200, were due and outstanding when foreclosure proceedings were instituted.
In 1932 the Glass Co. was unable to meet its obligations and its creditors demanded security for their claims.
On June 15, 1932, the Glass Co. issued sinking fund bonds in the amount of $ 75,000 to the same trustee for the purpose of refunding the bond issue of 1924, of which $ 26,000 were outstanding, and to pay or secure its other creditors. The bonds were to mature on June 15, *658 1937, and were secured by a mortgage on the manufacturing plant of the issuing corporation. Of the bonds issued, $ 20,500 par value was outstanding when foreclosure proceedings were instituted, as hereinafter set forth. The first mortgage bonds were never refunded, with the result that the security for the bonds issued in 1932 constituted a second mortgage on the manufacturing plant.
On August 1, 1935, the Glass Co. was unable to meet its bond interest, sinking fund, and current obligations. *56 Its liabilities at that time were $ 92,200. From that date until April 1, 1937, the outstanding first mortgage bonds in the amount of $ 26,000 were held by 10 individuals, an estate, and the First Jeannette Bank & Trust Co., successor to the Jeannette Savings & Trust Co., the latter owning $ 11,000 of the bonds. During the same period the second mortgage bonds, totaling $ 20,500, were held in 3 blocks and petitioner's outstanding common stock, consisting of 1,565 shares of a par value of $ 78,250, was held by 16 stockholders.
In August 1935 the Glass Co. was placed in receivership, with power in the receiver to continue operation of the business, and two individuals were appointed by the court to make an inventory and appraisal of the corporation's property. Later during the same month the court authorized the issuance of receivership certificates and received the report of the appraisers, which showed personal property in the amount of $ 14,288.87 and fixed assets in the amount of $ 130,158.84. Other orders of the court authorized the continuance of the receivership to April 10, 1937.
In 1936 negotiations were commenced to obtain working capital for the Glass Co., in connection*57 with which an application was filed with the Reconstruction Finance Corporation for a loan. After numerous discussions, the Reconstruction Finance Corporation agreed to provide working capital, conditioned upon the reorganization of the Glass Co. The plan adopted included foreclosure of the mortgages, the sale of property of the Glass Co., the organization of a new corporation, and the exchange of preferred stock of the new corporation for first mortgage bonds. The plan was carried out and at some undisclosed time the petitioner received a loan from the Reconstruction Finance Corporation. The plan for exchanging first mortgage bonds for preferred stock of the new corporation was discussed with the bondholders at meetings held in October and November 1936.
In October 1936 petitions were filed for leave to foreclose the two mortgages executed by the Glass Co. as security for bond issues. The petitions were granted and after advertisement the premises were purchased by the First Jeannette Bank & Trust Co., trustee, at a sheriff's sale held on January 29, 1937, for $ 1. At that time the assets were subject to liens for taxes in the amount of $ 5,283.78 and for costs of *659 *58 execution in the amount of $ 1,678.60. The sheriff's deed was executed on March 30, 1937.
The petitioner was organized on January 29, 1937, under the laws of Pennsylvania, with a capital stock consisting of 400 shares of 6 per cent noncumulative and nonvoting preferred stock of a par value of $ 100 each, and 10,000 shares of common stock of no par value. All of the common stock was issued to 3 individuals, who returned it to the petitioner as treasury stock. Later, 5,000 shares of the stock were reissued for $ 11,300.
On January 14, 1937, petitions were filed for the sale of the personal property of the Glass Co. at a public sale. On January 30, 1937, in accordance with an order of the court directing advertisement and sale of the property, the receiver sold the assets to petitioner for the amount of $ 11,000. The money paid in for stock was used to pay for the property.
The incorporators of petitioner, at a meeting held on February 3, 1937, adopted a resolution in which, after reciting that it had acquired title to certain real estate and other property formerly owned by the Glass Co., that the property was subject to a lien as security for $ 26,000 face amount of bonds and interest*59 thereon, and that in accordance with a plan of reorganization it was contemplated and agreed that the bondholders should receive in exchange for their bonds preferred stock of petitioner, authorized its officers to exchange shares of its preferred stock for first mortgage bonds of the Glass Co., on the basis of 6 shares of the former for $ 500 face amount, coupons attached, of the latter. Thereafter petitioner exchanged, on that basis, 312 shares of its preferred stock of a par value of $ 31,200 for $ 26,000 face amount of first mortgage bonds, coupons attached, of the Glass Co.
On April 1, 1937, the trustee for the first mortgage bondholders transferred to petitioner the property which it had purchased at the sheriff's sale held on January 29, 1937. The property had a fair market value at the time of the transfer as follows:
| General machinery | $ 20,617.00 |
| Carton machinery | 14,807.00 |
| Two diesel engines | 1 9,174.00 |
| Buildings | 49,209.87 |
| Lehrs | 3,111.91 |
| Tanks | 1.00 |
| Land | 8,000.00 |
| Office furniture and | |
| fixtures | 2 317.00 |
| Moulds | 3 2,259.00 |
| Delivery equipment | 3 94.00 |
| Total | 107,590.78 |
*60 Petitioner's preferred stock was entitled to dividends before payment of dividends on the common stock, was subject to redemption at $ 105 *660 a share on ten days notice to the holders thereof at any time after payment of indebtedness to the Reconstruction Finance Corporation, and upon liquidation was entitled to $ 100 a share before making distributions on common stock.
Each of three bondholders holding $ 1,000 face amount of the first mortgage bonds executed a document authorizing the trustee to act as his or her agent to make the exchange, with the understanding that the property purchased by the trustee on January 29, 1937, would be conveyed to petitioner, and that his or her interest therein was limited to the right to receive preferred stock. None of these bondholders intended to contribute to the capital of petitioner.
None of the common stockholders or first mortgage bondholders of the Glass Co. acquired common stock of petitioner.
The capital and surplus accounts of petitioner at the close of the taxable years, as disclosed in its returns, were as follows:
| 1942 | 1943 | |
| Preferred stock | $ 31,200.00 | $ 30,954.00 |
| Common stock | 9,754.00 | 10,000.00 |
| Earned surplus and undivided profits | 64,128.56 | 57,519.89 |
| Revaluation surplus | 23,125.82 |
*61 The assets acquired by petitioner on April 1, 1937, from the trustee were entered in petitioner's books as of February 10, 1937, at a cost of $ 38,697.22. Later during the same year the cost was first reduced to $ 38,163.38 by reprorating the cost, and then the assets were written up to the amount of $ 115,777.47.
In its excess profits tax returns for the taxable years 1942 and 1943, filed with the collector for the twenty-third district of Pennsylvania, the petitioner included in its computation of equity invested capital, as "Property paid in for stock, or as paid-in surplus, or as a contribution of capital," the amounts of $ 28,456.76 and $ 30,954, respectively, as the cost of the assets. In his computation of petitioner's equity invested capital for each taxable year, the respondent included $ 31,200 for assets paid in for preferred stock and $ 6,963.38 for liabilities assumed.
Amounts claimed in the returns of petitioner for depreciation were computed on the basis of cost. Respondent disallowed a portion of the amounts because of the use of a longer life for the assets.
OPINION.
The issues relate to the assets acquired from the trustee on April 1, 1937. The property was taken*62 up on the books of petitioner at the cost figure of $ 38,163.38 (as adjusted after the original entry), which amount is equal to the face amount of the *661 first mortgage bonds exchanged for preferred stock and interest thereon, plus tax liens and cost of execution in the foreclosure proceedings. 1 Later petitioner wrote up the assets to $ 115,777.47, an increase of $ 77,614.09.
In its returns the petitioner claimed equity invested capital and depreciation for the assets on the basis of cost. Respondent computed equity invested capital by including $ 31,200 as the cost of assets acquired for preferred stock, this amount being the face amount of and interest due on the bonds; also the par value of the stock issued in exchange therefor, and $ 6,963.38 as liabilities assumed, a total of $ 38,163.38. Adjustments made by the respondent to amounts claimed for depreciation are attributable to increases made in the life of the assets.
Equity Invested*63 Capital.
The petitioner contends here that the assets acquired from the trustee on April 1, 1937, had a fair market value of at least $ 115,777.47, and that the difference of $ 77,614.09 between the amount of $ 38,163.38 allowed by the respondent and such value should be included in equity invested capital as paid-in surplus or a contribution to capital under the provisions of section 718 (a) (2) of the Internal Revenue Code. 2 The respondent contends, as he determined when computing the deficiencies, that petitioner's basis is cost, measured by the fair market value of $ 31,200 for the preferred stock and $ 6,963.38 for liabilities of the Glass Co. which were assumed by petitioner. Thus, the basic difference between the parties under the issue is the proper basis to be used for inclusion in equity invested capital.
*64 The petitioner contends that it is entitled, under the provisions of section 113 (a) (8) of the code, 3 to use the basis of the trustee, the *662 transferor, and that its basis was the fair market value of the assets, without any adjustments for gain or loss to the transferor.
The transfer in question was a step in a reorganization of the Glass Co. under a plan adopted to*65 obtain a loan from the Reconstruction Finance Corporation for working capital, and the plan must be considered as a unit in considering the nature of the transfer. The plan involved foreclosure of the two mortgages and the exchange of first mortgage bonds for preferred stock of petitioner after the purchase of the assets by the trustee at the sheriff's sale and transfer of the property to petitioner. It was not intended under the plan that the bondholders should hold unencumbered title to the property. The bondholders agreed to substitute for their lien on the property, amounting to $ 31,200, preferred stock of petitioner of a par value of the same amount. Their role in the plan was to serve, through the trustee, as a conduit for the transfer of the property to petitioner. Thus it was not contemplated that they should have at any time an interest in the assets in excess of their lien.
The resolution adopted by the incorporators of petitioner on February 3, 1937, a few days after the foreclosure sale, discloses that petitioner was regarded as the owner of the property in question, subject to the lien of the mortgage securing the bonds. The resolution is evidence of an understanding*66 of petitioner's incorporators that the trustee was serving only as a conduit, with no greater interest in the assets than to receive preferred stock of petitioner in exchange for bonds.
There is no evidence of intention on the part of the bondholders to contribute to the capital of petitioner. Three of the bondholders testified that they had no such intention. See George P. Pitkin, 31 B. T. A. 403; Weaver v. Commissioner, 58 Fed. (2d) 757. Neither is there any evidence here that the amount was ever entered in the books of petitioner as paid-in surplus or a contribution to capital.
Under the circumstances the bondholders were never intended to have any interest in the property to transfer to petitioner as paid-in surplus or a contribution to capital and accordingly they realized no gain in a transaction that would serve to give petitioner a stepped-up basis in the assets to use for equity invested capital purposes.
The effect of the plan, as consummated, was that the petitioner acquired the lien of the bondholders in the assets for shares of its preferred stock, without regard to the actual value of the property.
Property*67 donated to a corporation by nonstockholders may not be included in invested capital. Frank Holton & Co., 10 B. T. A. 1317; Liberty Mirror Works, 3 T. C. 1018; McKay Products Corporation, 9 T.C. 1082">9 T. C. 1082; Brown Shoe Co., 10 T.C. 291">10 T. C. 291. Here, as already concluded, the bondholders, who became preferred stockholders of petitioner, *663 had no property rights in the assets, the value of which petitioner seeks to include in invested capital, and neither the Glass Co. nor its stockholders became stockholders of petitioner. Thus there was no consideration for the property and nothing was invested in the business for profit. La Belle Iron Works v. United States, 256 U.S. 377">256 U.S. 377. In Dill & Collins Co., 18 B. T. A. 638, relied upon by petitioner as controlling the question here, the applicable statute was 326 (a) of the Revenue Act of 1918 and preferred stock was issued for the property.
The respondent determined that the preferred stock issued for the bonds had a fair market value equal to its par value. *68 No evidence was offered by the petitioner to prove any other value for the stock. Such value represents the cost to petitioner of the assets acquired for stock. Christman Co., 8 T. C. 679; Difco Laboratories, Inc., 10 T. C. 660. Petitioner is not entitled to a greater amount for inclusion in equity invested capital.
Depreciation.
Petitioner's arguments with respect to exhaustion of the property is based upon the contentions it made under the invested capital question and concedes that our ruling on that issue controls this one. No reason appears for holding otherwise. Accordingly, we sustain the respondent on this question. See Detroit Edison Co. v. Commissioner, 318 U.S. 98">318 U.S. 98.
Decision will be entered for the respondent.
Footnotes
1. Sold in 1941.↩
2. Fair market value not in controversy.↩
3. Charged off December 31, 1939; fair market value not controversy.↩
1. There is an unexplained difference of $ 1 which is not in dispute.↩
2. SEC. 718. EQUITY INVESTED CAPITAL.
(a) Definition. -- The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) --
* * * *
(2) Property paid in. -- Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. * * *↩
3. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(8) Property acquired by issuance of stock or as paid-in surplus. -- If the property was acquired after December 31, 1920, by a corporation --
* * * *
(B) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.↩