*1791 1. A corporation which discharges its outstanding bonds by issuing to the bondholders shares of its preferred stock, par for par, may not deduct from its gross income, in the year in which the transaction takes place, the unamortized discount on the bonds, as the issuance of stock is a mere change in its capitalization and is not an outlay of either cash or property. The fact that the stock issued was actually worth par is immaterial.
2. Liability of a transferee held not barred by limitation, upon a finding that notice was mailed to it within one year after expiration of the statutory period for assessment against the taxpayer. Section 280(b)(1), Revenue Act of 1926.
3. Liability of a transferee of a transferee held barred by limitation, upon a finding that notice was mailed to it more than three years after expiration of the statutory period for assessment against the taxpayer. Section 311(b)(2), Revenue Act of 1928.
*969 Respondent has asserted against 375 Park Avenue Corporation transferee*1792 liability for a deficiency of $14,324.80 in income and profits taxes of the Montana Realty Company for 1920; of this amount said *970 petitioner has consented to the assessment of $3,308.77, which has been paid. He has further asserted the same liability, reduced to $10,954.91, against 373 Park Avenue Corporation, as transferee of 375 Park Avenue Corporation and the Montana Realty Company. In determining the liability of the original taxpayer, the Commissioner disallowed the deduction of alleged bond discount. Petitioners further contend that collection of the deficiency is barred by the statute of limitations.
FINDINGS OF FACT.
The following stipulation was received in evidence:
1. It is hereby stipulated and agreed by and between counsel for the respective parties hereto that the following facts may be taken as true and considered as evidence in the consideration of the above-entitled appeals, subject to the right of each of the parties hereto to introduce further evidence at the hearing of the proceeding.
2. That the deficiency involved in said appeals is the additional income and profits tax liability of the Montana Realty Company, a New York corporation, *1793 for the calendar year 1920 determined by the Commissioner in the aggregate sum of $10,954.91, and that the figures used in and as basis for respondent's sixty-day letter of August 8, 1929, addressed to the 373 Park Avenue Corporation (Docket No. 45913), are the figures used herein and shall have reference to both cases, unless otherwise specifically provided.
3. The Montana Realty Company (the taxpayer and transferor company), being engaged in the business of buying, selling and operating real estate with its principal office at 30 East 42nd Street, City and State of New York, filed an income and excess profits tax return on Form 1120 for the calendar year 1920, on March 14, 1921, with the Collector of Internal Revenue for the second district of New York. Said return showed a net taxable income of $110,604.57 on which a tax of $14,974.90 was assessed and paid.
4. On December 11, 1922, the Montana Realty Company was dissolved under the laws of the State of New York, and pursuant to a plan of reorganization, all of its property and assets were transferred to 375 Park Avenue Corporation, which property and assets had a net value in excess of the amount of tax involved herein.
*1794 That the consideration for the transfer of the property and assets of the Montana Realty Company to the 375 Park Avenue Corporation was the issue of the entire capital stock of the 375 Park Avenue Corporation to the stockholders of the Montana Realty Company.
The 375 Park Avenue Corporation (the first transferee company) was incorporated under the laws of the State of New York on November 23, 1922, with its principal office at 30 East 42nd Street, in the City and State of New York.
5. On December 8, 1926, the 375 Park Avenue Corporation was dissolved under the laws of the State of New York, and pursuant to a plan of reorganization, all of its property and assets were transferred to the 373 Park Avenue Corporation, which property and assets had a net value in excess of the amount of tax involved herein.
That the consideration for the transfer of the property and assets of the 373 Park Avene Corporation to the 373 Park Avene Coruporation was the *971 issue of the entire capital stock of the 373 Park Avenue Corporation to the stockholders of the 375 Park Avenue Corporation.
The 373 Park Avenue Corporation (the second transferee company) was incorporated under the*1795 laws of the State of New York on November 9, 1926, with its principal office at 30 East 42nd Street in the City and State of New York.
6. On February 25, 1927, the respondent mailed a notice of deficiency in tax in the amount of $14,324.80 to the 375 Park Avenue Corporation, as transferee of the assets of the Montana Realty Company, no notice of deficiency as to its said tax having been mailed to said Montana Realty Company other and except the two deficiency letters mailed to the 375 Park Avenue Corporation and the 373 Park Avenue Corporation on February 25, 1927, and August 8, 1929, respectively, with statements attached, copies of which are attached hereto and made a part hereof. Subsequently, the 375 Park Avenue Corporation consented to the assessment of $3,308.77 of the proposed deficiency and said amount was assessed against the 375 Park Avenue Corporation in April, 1927. Said amount of $3,308.77 was paid May 9, 1927. An appeal was filed from said deficiency noticed mailed to the 375 Park Avenue Corporation on February 25, 1927, which appeal bears the docket number 25976 and is still pending.
7. On August 8, 1929, the respondent mailed a notice of deficiency in tax*1796 in the amount of $10,954.91 to the 373 Park Avenue Corporation, as transferee of the 375 Park Avenue Corporation, the transferee of the Montana Realty Company, from which notice an appeal was taken and is now pending under docket number 45913.
8. On February 1, 1917, the Montana Realty Company issued $400,000 par value of its twenty year, six per cent, second mortgage bonds at a discount of $98,000. Prior to January 1, 1920, $212,000 par value of these bonds were redeemed for cash, leaving $188,000 par value outstanding as of January 1, 1920. On April 20, 1920, the Montana Realty Company issued $188,000 of its six per cent first preferred stock, receiving in full payment thereof said $188,000 par value of its outstanding bonds which were retired and cancelled. On this latter date the unamortized discount on the bonds amounted to $46,060. Of this amount $7,409.24 is not in dispute, as $6,717.08 has been allowed for years prior to 1920 and $692.16 for the period January 1, 1920, to April 20, 1920, leaving a balance of $38,650.76 unamortized bond discount in dispute. This amount of $38,650.76 was included in the amount deducted by the Montana Realty Company as interest paid in*1797 the year 1920 and was disallowed by the respondent in the audit of said return.
9. No assessment has ever been made against the said Montana Realty Company, the said 375 Park Avenue Corporation, or the said 373 Park Avenue Corporation, as to that part of the proposed deficiency now in dispute, namely, $10,954.91.
10. It is further stipulated and agreed, by and between the parties hereto, that if any liability for outstanding and unpaid taxes be determined by the Board to be now due and payable, that both the 375 Park Avenue Corporation and the 373 Park Avenue Corporation may be held liable in this proceeding as a transferee of the Montana Realty Company and a transferee of such transferee, respectively, under the provisions of Section 280 of the Revenue Act of 1926 for any amount of tax which the Board may determine to be due and payable, provided, however, that it is found in this proceeding that the statute of limitations upon the assessment and collection of the tax or liability therefor is not barred by the operation of the statute of limitations as to either or both petitioners.
*972 On April 20, 1920, when the Montana Realty Company issued its 6 per cent first*1798 preferred shares of the par value of $188,000, it increased its capital shares at the same time by the issuance of second preferred shares of the par value of $100,000, all of which were purchased at par for cash by Manton B. Metcalf, who also acquired a fourth of the first preferred.
Under date of March 18, 1920, Benjamin Mordecai, treasurer of the Montana Company, addressed to parties holding in it controlling interests a letter in which he stated that the company had outstanding against it second mortgage bonds aggregating $188,000 which had to be satisfied, and he suggested that he and three others subscribe in equal amounts $188,000 for first preferred shares of like par value to be issued by the company. He added that: "The $188,000 realized by the Company by the sale of its first preferred stock would be used to retire the present second mortgage bonds." In the course of the letter he said that the company had "with the approval of the Government every year deducted as an expense the sum of $245 for every $1,000 bond retired. By retiring this $188,000 of bonds during the year 1920, we will be enabled to deduct as an expense for the year 1920 the sum of $46,060." The proposition*1799 contained in this letter was accepted by the stockholders to whom addressed - all financially responsible persons.
At a stockholders' meeting held April 9, 1920, a resolution was duly passed, authorizing that the company's capital stock be increased by the issuance of $188,000 first preferred shares and $100,000 second preferred. Thereafter the board of directors, on April 20, 1920, passed the following resolutions:
Resolved, that the corporation accept the subscriptions, at par, for said preferred stock from the stockholders and in proportions set forth in such written consent, and that the corporation accept in payment of any of the subscriptions to first preferred stock, the second mortgage bonds, at par, issued by this corporation and dated February 1, 1917.
* * *
Resolved, that all of the outstanding bonds which are secured by the trust mortgage made by this corporation to Franklin Trust Company, dated February 1, 1917, be, and the same hereby are, called for redemption.
The bonds contained no provisions rendering them convertible into stock. The first preferred stock issued was worth par.
OPINION.
STERNHAGEN: 1. The Commissioner, in our opinion, correctly*1800 disallowed the deduction by the Montana Company in 1920 of any amount in respect of the retirement of its outstanding bonds and the issuance therefor of preferred shares. The corporation in 1917 *973 borrowed $302,000 in cash and promised to pay $400,000, for which it issued its bonds. In other words, the bonds were "sold at a discount" of 24 1/2. In 1920, $188,000 par value of these bonds were outstanding and the corporation, instead of paying them off in cash, discharged them by issuing preferred shares to the bondholders, par for par. This was not a loss to the corporation. It was a change in its capitalization. Instead of suffering the outlay of money in excess of the amount borrowed, it created a new distribution of its shares, thus avoiding its fixed financial obligation and devoting the borrowed money to the ordinary risks of its business. A corporation pays nothing by issuing shares. It only readjusts its capital. ; ; affirmed on this point, *1801 .
It does not matter that the shares issued were in fact worth par. As to the issuing corporation, they did not represent an outlay of either cash or property. The corporation's assets remained intact. While the value of the shares may determine gain or loss to the recipient as to whom they are ordinary property, it has no such significance to the corporation, as to which the shares are mere evidences of ownership in the enterprise. Cf. .
The petitioner argues that since the apparent intention was to treat the retirement as if cash had passed and since the effect was the same, its tax liability should be determined as if cash had been paid by shareholders for the new shares and used by the corporation to pay its bond obligations at par. But the facts must control. 1; .
*1802 In our opinion, the Commissioner, in determining the net income of the Montana corporation, correctly disallowed the deduction claimed.
2. The Montana return was filed March 14, 1921, and the limitation period would have expired March 14, 1926. Meanwhile it transferred its assets to the 375 Park Avenue Corporation and dissolved. It is stipulated that the 375 Corporation is liable as transferee save for the statute of limitations. The notice of such liability was mailed to the 375 Corporation on February 25, 1927, which was within one *974 year after the expiration of the Montana Corporation's period. This was timely as provided by section 280(b)(1), Revenue Act of 1926, then in effect. No assessment against the Montana Corporation was necessary, . The liability of the 375 Corporation is therefore sustained, and in Docket No. 25976 judgment will be entered for the full amount of the deficiency.
3. The assets of the 375 Corporation were transferred to the 373 Park Avenue Corporation, and it is stipulated that the latter may be held liable as transferee of the transferee save as the liability may be barred by limitation. *1803 The notice to the 373 Corporation was mailed August 8, 1929, and its liability is governed by the Revenue Act of 1928. Section 311(b)(2) provides that the period of limitation is:
(2) In the case of the liability of a transferee of a transferee of the property of the taxpayer, - within one year after the expiration of the period of limitation for assessment against the preceding transferee, but only if within three years after the expiration of the period of limitation for assessment against the taxpayer * * *.
The period as to the taxpayer (Montana Corporation) expired March 14, 1926, and since the statute as to the 373 Corporation expired three years thereafter, or on March 14, 1929, and the notice to it was not mailed until August 8, 1929, the liability of the 373 Corporation is barred.
In Docket No. 45913, judgment of no deficiency will be entered.
In Docket No. 25976 judgment will be entered for the respondent. In Docket No. 45913 judgment will be entered for the petitioner.
Footnotes
1. Even if cash had been paid, an interesting query would arise as to whether, since the payment of less than the amount borrowed has been held not to result in gain, ; Kirby Lumber Co. v.United States↩ Fed.(2d) (Ct. Cls., Dec. 1, 1930) (now on review in U.S. Supreme Court), the payment of more than the amount borrowed results in loss. Cf. .