*694 The evidence establishes that stock and debentures of a new corporation, acquired in exchange for stock of an old corporation in a nontaxable reorganization, had no market value. Held, that because of the lack of market value, no allocation of basis can be made between the new stock and debentures and no gain is to be recognized on a transaction whereby the petitioners exchanged part of their new stock for the cancellation of indebtedness in amounts less than the basis of the old stock.
*824 These are proceedings for the redetermination of deficiencies in income tax for the year 1931 as follows: H. A. Green, $52,805.04; Clarke E. Dye, $6,115.19. Both petitioners allege that the respondent erred in determining the basis for gain or loss of stock of the Furniture Corporation of America, Ltd., which the petitioners exchanged in 1931 in satisfaction of indebtedness. The basis was determined by respondent by allocating between stock and debentures the cost to petitioners of other corporate stock exchanged therefor in a non-taxable reorganization.
*695 An alleged error as to the cost of petitioner Green's stock in the Doernbecher Manufacturing Co. was settled by respondent's concession that the cost alleged by petitioner is correct. No evidence was offered on an issue as to the profit realized by petitioner Green on the exchange of debentures of the Furniture Corporation of America, Ltd., for stock of the same corporation. The proceedings were consolidated.
FINDINGS OF FACT.
In 1930 petitioner Green was the owner of 8,135 1/2 shares of stock of the Doernbecher Manufacturing Co., an Oregon corporation, hereinafter called the Doernbecher Co., which was engaged in the manufacture and sale of furniture. Petitioner Dye owned 1,356 shares. Green's stock had cost him $466,460.42 and Dye's had cost him $85,923.73. In both cases cost was the basis for gain or loss.
On June 23, 1930, a Nevada corporation was organized under the name of Furniture Corporation of America, Ltd., hereinafter called the Furniture Corporation, for the purpose of consolidating the *825 businesses of a number of furniture companies on the Pacific Coast. Its authorized capital stock consisted of 1,000,000 shares of no par value. It was also to*696 issue 15-year sinking fund gold debentures in the face amount of $2,750,000, bearing 6 1/2 percent interest. Prior thereto 10 furniture companies had entered into so-called option agreements with a banking firm whereby the Furniture Corporation, if and when organized, had the right to acquire the properties and businesses of the 10 at an agreed price in each case payable 25 percent in cash and 75 percent in stock of the Furniture Corporation. It was provided in the agreements that the Furniture Corporation proposed to acquire all the stock of the Doernbecher Furniture Co. It was also provided that the stock of the Furniture Corporation was to be valued at $20 per share for transfer purposes under the option agreements. It was further provided that the bankers should have the right to purchase one third of the stock to be issued to the 10 merging companies at prices ranging from $20 to $30 per share, depending on the date of purchase.
The option agreements were not complied with by August 1, 1930, the date of expiration, and under date of September 1, 1930, supplemental option agreements were executed by the 10 companies whereby they agreed to accept shares of stock and debentures*697 of the Furniture Corporation for their properties. By other agreements executed at the same time the 10 companies agreed with the bankers to accept the debentures of the Furniture Corporation in lieu of the cash payments provided for in the first option agreements, and the bankers agreed to purchase the debentures from the 10 companies within 120 days at 85 percent of the par value thereof. The agreement of the bankers, under the several contracts, was to purchase the entire issue of debentures in the face amount of $2,750,000.
The bankers were unable to comply with their agreement to purchase the debentures and asked for an extension of time. In the meantime the properties of the 10 companies were transferred to the Furniture Corporation. Of the 10 companies 7 refused to grant the bankers any further extension. Thereupon, in March 1931 those 7 companies withdrew from the merger, receiving back the properties they had turned in and returning to the Furniture Corporation the stock and debentures they had received.
The figures upon which the merger was originally projected showed a net worth for the 10 merging companies of $3,948,199.09 and $5,458,729.09 for the Doernbecher*698 Co., a total of $9,406,928.18. These figures did not represent true values. They were based on appraisals made in 1929, when values were at the highest ever known in the furniture business, and much higher than in 1930, when the merger *826 was attempted. In assembling the figures for the proposed merger the bankers arbitrarily assigned good will to various companies in the group. In the figures finally agreed upon the Doernbecher Co. was given a good will value of $2,065,862 and the other 10 were assigned good will values aggregating $1,196,880. The asset figures assembled and used on a basis for the proposed merger of the 10 companies were greatly in excess of the then actual values of the assets of the companies.
Neither the Doernbecher Co. nor any of its stockholders were parties to any of the agreements above described. Petitioners were, however, familiar with the various transactions. In June 1930 the petitioners and one other person, E. S. Beach, owned all the outstanding stock of the Doernbecher Co., except one block which was owned by B. P. John and held in escrow pending the purchase of it by the Doernbecher Co. These three stockholders had likewise deposited*699 their stock with the escrow holder as security for the performance of the purchase contract.
In 1930 the petitioners assigned to the Furniture Corporation their stock in the Doernbecher Co. excepting one share in each case. Under the terms of the assignment the Furniture Corporation assumed the liability of the petitioners under their collateral agreements to secure the purchase of the B. P. John stock. Petitioner Green received $862,069 par value of Furniture Corporation debentures and 123,748 shares of stock of that corporation. Petitioner Dye received $143,678 par value of debentures and 20,626 shares of Furniture Corporation stock.
The petitioners at that time were indebted to the Doernbecher Co. Before assigning their Doernbecher stock to the Furniture Corporation they had reached an agreement with the Doernbecher Co. that they would be permitted to liquidate their debts by transferring to it Furniture Corporation stock at a value of $20 per share.
On February 19, 1931, resolutions were adopted by the Doernbecher Co. stockholders and directors authorizing the acceptance of the Furniture Corporation stock at $20 per share in full satisfaction of the indebtedness of*700 petitioners Green and Dye and one other stockholder. Green accordingly transferred 23,018 shares of Furniture Corporation stock to the Doernbecher Co. in satisfaction of his indebtedness in the amount of $460,360. Petitioner Dye transferred 2,893 shares in satisfaction of his debt in the amount of $57,860.
The petitioners did not report any gain realized on the transfer of Furniture Corporation stock in satisfaction of their indebtedness.
The respondent allocated the total cost of Doernbecher stock between *827 the Furniture Corporation stock and debentures and arrived at a cost per share of Furniture Corporation stock of $2.801776 1 in the case of petitioner Green and $3,0896814 in the case of petitioner Dye. Using these figures, the respondent has determined that the 23,018 shares turned in by petitioner Green had a basis of $64,491.28 and that the difference between that sum and the $460,360 indebtedness canceled represents gain, the amount so calculated being $395,868.72. In the case of petitioner Dye the respondent determined the basis of 2,893 shares turned in to be $8,938.45 and the difference between that sum and the $57,860 indebtedness canceled to be gain*701 in the amount of $48,921.55.
The firm of bankers managing the merger of the several furniture companies went into bankruptcy at some time not disclosed by the record.
Neither the stock nor debentures of the Furniture Corporation were listed on any stock or bond exchange. There were no sales of either the stock or debentures in 1930 or 1931.
The Furniture Corporation was unable to meet the interest on its debentures, and, in an attempt to avert receivership, the majority of holders of debentures turned them back to the corporation some time after 1931 and received stock for them.
Neither the stock nor the debentures of the Furniture Corporation had a fair market value in 1930 or 1931.
OPINION.
ARUNDELL: The parties are in agreement as to the cost to petitioners of their Doernbecher Co. stock, and further that the exchange of that stock for Furniture Corporation stock and debentures was a nontaxable exchange. Counsel for*702 petitioners also concedes that the transfer of Furniture Corporation stock at $20 per share in cancellation of the petitioners' indebtedness would be a taxable transaction if it were practicable to make an allocation of basis between the stock and debentures.
It is the contention of the petitioners that it is impracticable to apportion the cost of the Doernbecher stock between Furniture Corporation stock and debentures and that the respondent's apportionment is wholly arbitrary and has no basis or foundation in fact. Then they say that it being impracticable to apportion cost, there can be no gain or loss until they have disposed of enough of the new stock and debentures to have recovered their entire cost of the old stock *828 and thereafter all the balance received will be profit, or, if an insufficient amount is realized on the disposition of all the stock and debentures to equal the cost of their old stock, there will be a loss.
There is no provision in the statute (Revenue Act of 1928) directing either an apportionment of cost between two or more kinds of property received in a nontaxable exchange, nor is there any statutory authorization for deferring the reporting*703 of a profit where an apportionment is impracticable. However, for a number of years the respondent's regulations have provided for apportionment of cost under various circumstances and for the deferment of recognition of gain until full cost is recovered where apportionment is impracticable. See art. 39, Regulations 45; arts. 39, 1567, Regulations 62; art. 39, Regulations 65 and 69. The validity of these regulations has been recognized. See Salvage v. Commissioner, 76 Fed.(2d) 112, and cases there cited. Article 1567 of Regulations 62, interpreting the Revenue Act of 1921, provided in part as follows:
* * * the proportion of the original cost, or other basis, to be allocated at each class of new securities is that proportion which the market value of the particular class bears to the market value of all securities received on the date of the exchange. * * * [Italics supplied.]
Regulations issued under subsequent revenue acts do not contain the exact language that appears in the foregoing quotation. It has been held, however, that the quoted provision lays down a principle that is equally applicable in determining gain or loss under subsequent*704 revenue acts. See I.T. 2335, C.B. VI-1, p. 18, so holding with respect to the Revenue Act of 1926, which we approved in Glenn H. Curtiss,21 B.T.A. 629">21 B.T.A. 629; affd., 57 Fed.(2d) 847, a case arising under the Revenue Act of 1924; Sallie Strickland Tricou,25 B.T.A. 713">25 B.T.A. 713, involving the Revenue Act of 1926. Cf. Edwin D. Axton,32 B.T.A. 613">32 B.T.A. 613, a case under the Revenue Act of 1928.
In making his allocation of basis the respondent started out with the assumption that the Furniture Corporation stock was worth $20 per share and the debentures were worth their face value. His computation then, in the case of petitioner Green, was as follows:
| Securities received | Value | Percentage | Cost |
| 123,478 shares stock | $2,474,960.00 | 74.16657 | $345,957.69 |
| Debentures | 862,069.00 | 25.83343 | 120,502.73 |
| Total | $3,337,029.00 | 100.00000 | $466,460.42 |
$345,957.69 divided by 123,478 shares - $2.801776 - Cost per Share.
A similar computation in the case of petitioner Dye resulted in a determined cost of $3.0896814 per share.
*829 It is plain enough we think that $20 per share for the stock and face value for the*705 debentures did not represent market values of those securities when received by the petitioners. The evidence is that the valuation figures which were assembled as a basis for the merger of the furniture companies were based on appraisals made at peak prices in 1929, plus arbitrary good will values, and that those figures were far above true values in 1930 when the companies were tentatively brought together. The testimony of Green, who was thoroughly familiar with the entire transaction, is that the merger negotiations amounted to a "horse trading" proposition, and that the figures used did not purport to represent actual values. Even if we assume that when the first agreements were signed by the constituent companies their assets would support a value of $20 for the stock and par for the debentures, that situation did not obtain when the merger was actually consummated. The companies never received the cash called for by the agreements; they consented to take debentures in lieu of cash under an agreement that the debentures were to be taken up for cash and that agreement was not fulfilled; 7 of the 10 companies withdrew and of course took their assets out of the merger; the bankers*706 failed without completing their contracts. The so-called net worth of the three companies remaining in the merger was $883,055.93 as compared with the figure of $3,948,199.09 for the 10 who originally agreed to join. This situation gives ample support for petitioner Green's testimony that it "looked ridiculous" to assign a value of $20 to the stock and to treat the debentures as worth par.
The evidence goes further than establishing error in the values ascribed by respondent to the stock and debentures. It establishes that neither of them had a market value. Petitioner Green so testified, and he was thoroughly familiar with the merger negotiations; he was president of both the Doernbecher Co. and the Furniture Co.; he was an experienced furniture manufacturer, having been in the furniture business more than a quarter of a century. His testimony is fully supported by other evidence. The stock and debentures were not listed on any exchange and there were no sales of either of them. The merger or consolidation of the several companies into the Furniture Corporation was conceived when prices were at an extreme high, and the plans for bringing the companies together were based*707 on the peak prices of 1929, to which were added arbitrary figures for good will. The bankers who were managing the negotiations apparently ignored the financial cataclysm of 1929 and attempted to complete the merger on the basis of prices which to a great extent were nonexistent. They tried and failed. It is inconceivable that the comparatively minor group of assets finally brought together *830 could give any substantial value to the huge issue of debentures and stock which were designed to be issued on the padded peak prices for the assets of all 10 companies plus the Doernbecher stock. During the year 1930 the whole matter was in a state of flux. The bankers were having to change their plans; prices were falling; it was not known what companies would finally be in the merger, and it could not be known what assets the new company would have. In these circumstances we are of the opinion that the stock and debentures had no market value and we have so found as a fact.
As above pointed out, the principle of allocation is based on market value. Where there is no market value, no allocation can be made and the taxpayer is entitled to recover his entire original basis*708 before gain or loss will be recognized on the disposition of the new securities.
Edwin D. Axton, supra.
As the evidence in these cases not only shows the respondent's allocation to have been erroneous, but further establishes that the new securities had no market value when acquired by the petitioners, we hold that the petitioners may recover the full cost of their Doernbecher stock before gain or loss will be recognized. The debts which were canceled in 1931 in consideration of the Furniture Corporation stock were less than cost of the Doernbecher stock and no gain is to be recognized to petitioners on that transaction.
Decision will be entered under Rule 50.
Footnotes
1. An error was made in the case of petitioner Green in understating cost of Doernbecher stock by $15,000. This is conceded by respondent and the figure above given is the cost arrived at using the corrected cost of the Doernbecher stock. ↩