*1958 1. The original cost of stock, with respect to which stock rights have been received and exercised, must be adjusted to give effect to the acquisition of the new stock in determining the basis for computing gain or loss upon the sale of a portion of such stock. Miles v. Safe Deposit Co.,259 U.S. 247">259 U.S. 247, and Frederick Ayer,6 B.T.A. 152">6 B.T.A. 152; affd., 25 Fed.(2d) 534, followed.
2. The sale of securities by a corporation to its sole stockholder at a price in excess of cost and March 1, 1913, value results in taxable gain.
*1190 Respondent has determined a deficiency against petitioner of income and profits taxes for the calendar year 1920 in the amount of $294,388.42. The error alleged is that respondent has increased petitioner's net income by $1,055,953.12, alleged profit from the transfer in 1920 of 225,000 shares of British-American Tobacco stock by petitioner to its sole stockholder, the estate of P.A.B. Widener, deceased.
FINDINGS OF*1959 FACT.
Petitioner is a corporation organized and existing under the laws of Pennsylvania, with its principal office at 405 Land Title Building, Philadelphia, Pa.
In 1911 P. A. B. Widener was a large stockholder in the Standard Oil Co. and the American Tobacco Co. In 1911 these companies were dissolved pursuant to a decree of the Supreme Court of the United States. Under this dissolution there came into the hands of P. A. B. Widener stock of companies incorporated in many of the different States and in Great Britain and having a value of about $20,000,000, P. A. B. Widener was then about 80 years of age and his affairs were attended to by his son, George D. Widener. Counsel for P. A. B. Widener advised George D. Widener that death duties upon his father's estate could be avoided to a certain extent by putting all of his securities, other than those of Pennsylvania corporations, into a Pennsylvania corporation. Upon being approached on the subject P. A. B. Widener rejected the plan.
George D. Widener was lost on the Titanic on April 12, 1912. In the meantime P. A. B. Widener had purchased, at a cost of some $3,000,000 to $4,000,000, a large tract of land in Philadelphia*1960 and built thereon the Widener Memorial School for Crippled Children, hereafter referred to as the Charity. After the death of George D. Widener, P. A. B. Widener sent for his counsel and stated that he then had no one to advise him and that he was anxious to create a safe endowment for the Charity. He stated to counsel that he desired the endowment to be $4,000,000, and that he might raise it to $5,000,000, and he desired to place a lien upon his whole fortune to secure the endowment. Counsel advised Widener that under the laws of Pennsylvania this plan was not feasible, but that Widener might transfer to petitioner all of his non-Pennsylvania securities, and against these securities have petitioner issue debentures which would serve the purpose of the endowment. Widener told counsel to proceed accordingly. All of Widener's non-Pennsylvania securities, *1191 except one share of United States Steel, which was reserved in order to qualify Widener as a director in that corporation, were transferred as of May 1, 1912, to petitioner is consideration of $5,000,000 of capital stock; $5,000,000 of script convertible into capital stock at the option of petitioner; first 4 per cent*1961 debentures in the amount of $5,000,000 and 6 per cent debentures in the amount of $10,000,000. The whole issue of stocks and bonds aggregating $25,000,000 par value thus became the property of Widener. Subsequently, in 1912, a deed of trust was executed and $4,000,000 of the $5,000,000 first 4 per cent debentures were delivered to the Land Title & Trust Co. of Philadelphia to hold the same in perpetuity as an endowment for the Charity.
P. A. B. Widener died testate in the year 1915. After making certain devises and legacies, practically the whole of the estate of Widener was by his will left in a long term trust. The Charity was not mentioned in the will and received nothing thereunder. The estate of Widener consisted of securities of Pennsylvania corporations, including the stock in petitioner, some real estate, his qualifying share in the United States Steel Corporation, and his collection of pictures which eventually will go to the city of Philadelphia. All his interests in non-Pennsylvania corporations had, as above set forth, been conveyed to petitioner and was at the date of his death owned by it. No death taxes were paid to any of the State other than Pennsylvania*1962 upon the non-Pennsylvania stocks or securities by reason of the death of P. A. B. Widener.
The executors and trustees under the will of Widener were his surviving son, Joseph E. Widener, and his grandson, George D. Widener, son of testator's deceased son, George D. Widener. The directors and officers of petitioner were said Joseph E. Widener, said George D. Widener, grandson of P. A. B. Widener, and one Ballard. Ballard has been secretary and treasurer of petitioner since May 1, 1912, and was counsel for P. A. B. Widener until his death and later for his estate. Ballard has received no compensation as counsel for the estate, but he receives annually from petitioner the sum of $20,000, which covers both his services as secretary and treasurer of petitioner and also his services as counsel for the estate. The trustees have not received commissions from the estate, but each has been paid annually the sum of $25,000 as salary as an officer of petitioner. In 1920 and for many years prior thereto the clerks and bookkeepers of the estate and the office expenses thereof were paid by petitioner. At times when petitioner or the estate was in need of funds or either desired stock to*1963 hypothecate and it seemed more desirable that the transaction should be in the one name or the other, transfers would be made and proper entries made on the books of both.
*1192 Two years after the death of P. A. B. Widener, petitioner's capital structure was reduced to $2,000,000 capital stock and $4,000,000 of debentures, being the same debentures deposited with the trustee for the Charity. The issues of $10,000,000 of 6 per cent debentures, $1,000,000 of the 4 per cent debentures, $3,000,000 of stock, and $5,000,000 of script were canceled and cremated. This was accomplished by transferring from petitioner to the trustees of the estate securities of value equal to the securities canceled, and if there was a difference in value it was entered on the books of each as a credit or debit as the case might be.
The trustees of the estate of Widener continued to hold all petitioner's stock except the qualifying shares of the directors, which were in fact owned by the estate. The trustee for the Charity held the $4,000,000 debentures until 1920. In that year the trustees of the estate desired to substitute for these debentures certain real estate bonds on properties owned*1964 by the estate of Widener. To this the trustee for the Charity consented and the substitution was made. In this way the estate of Widener became the owner of $4,000,000 of debentures which constituted a claim in favor of the estate against the petitioner.
In 1920 the trustees of the estate transferred to petitioner these debenture bonds of the value of $4,000,000 and sundry stocks of a value of $299,287.78, canceled an open account due said estate from petitioner of $250,417.78 and credited petitioner on its books with $737,794.44. In exchange therefor petitioner transferred to the estate 225,000 shares of stock of the British-American Tobacco Co. of a market value of $23.50 per share, or a total value of $5,287,500, and charged the estate with the balance of $737,794.44. Two hundred and twenty-five thousand shares of the British-American Tobacco Co. stock were acquirred by petitioner from P. A. B. Widener in 1912 at a cost of $3,966,002. The value of said shares on March 1, 1913, was $5,315,625, or $23.625 per share. In 1919 petitioner acquired the right to subscribe for new shares of the British-American Tobacco Co. to the extent of one-third of its holdings and exercised*1965 this right by the payment of $326,437.50, increasing its holdings to 300,000 shares and making the average cost $18.806875 per share, and upon this basis respondent has computed the gain on the transfer above set forth. The certificates transferred were those which evidenced the original holding of 225,000 shares.
Joseph Widener, who was the president of petitioner and one of the trustees of the estate, told Ballard that he desired to make the substitution of securities in the Charity's endowment above set forth. Ballard, as secretary and treasurer, arranged the transaction and wrote it up on the minutes, which were approved by the other directors. Every year Ballard received proxies from the stockholders *1193 of record. He held the meetings in his office and wrote up the minutes. There never has been a meeting of stockholders or directors in which the stockholders and directors sat around a table and made motions or passed resolutions. The consultations between officers and stockholders have been informal.
OPINION.
PHILLIPS: Petitioner makes the following contentions: (1) That it and the estate of P. A. B. Widener (hereafter referred to as the estate) are one*1966 and the same entity and neither gain nor loss can result from transactions between them, and (2) that the March 1, 1913, value as a basis for determining gain or loss upon the stock sold by petitioner should not be affected or decreased by the exercise of stock rights at a subsequent date.
While the petitioner does not present any argument upon the second point, some explanation is necessary to understand the manner in which the controversy arises. In 1911 or 1912 petitioner acquired 225,000 shares of the stock of British-American Tobacco Co. at a cost of $3,966,002. On March 1, 1913, these shares had a value of $5,315,625. In 1919 the petitioner received stock rights which it exercised, acquiring 75,000 additional shares at a cost of $326,437.50. In 1920 it sold 225,000 shares to the estate for $5,287,500, which was their market value on the date of sale. Upon its income-tax return petitioner claimed a loss of the difference between the selling price and a March 1, 1913, value of $5,315,625. The Commissioner made the following adjustment in the cost or March 1, 1913, value:
| 225,000 shares, March 1, 1913, value | $5,315,625.00 |
| 75,000 shares, acquired on exercise of stock rights for | 326,437.50 |
| 300,000 shares | 5,642,062.50 |
| 1 share | 18.806875 |
| 225,000 shares | 4,231,566.88 |
*1967 The application of the averaging method of computing the cost basis for determining gain or loss on the sale of stocks with respect to which there have been stock dividends or subscription rights has been approved by the courts and this Board in , and , affd., . By reason of the application of this principle the Commissioner has determined that there was a profit to petitioner of $1,055,953.12 on the sale of this stock instead of a loss of $28,125 as claimed by petitioner upon its return. The petitioner does not now argue before the Board that the method of computing the gain was incorrect, but relies entirely upon its contention that the corporation and the estate are the same entity. If this contention were logically applied it would follow that all income received by the *1194 corporation since its organization was properly taxable as income of P. A. B. Widener and his estate and should have been added to any other income which Widener and his estate received during these years and taxed at the rates applicable to individuals rather than*1968 returned by the petitioner and taxed at the rates fixed for corporations. For the purposes of inheritance and transfer taxes imposed by the various States upon the transfer of the stocks owned by petitioner the corporate entity should have been disregarded upon the death of Widener and these stocks subjected to whatever taxes would have been payable had they been owned by the decedent. But petitioner does not seek to carry its contention to such a conclusion. Having enjoyed the benefits which resulted from its separate existence, it seeks to perpetuate those benefits and asks that the separate existence and tax liability of the petitioner and its single stockholder be overlooked only with respect to transactions which take place between them. That this is an afterthought is plainly evidenced by the action of petitioner in claiming a deduction upon this same transaction when it believed a deductible loss had been sustained.
Stress is laid upon the purpose for which petitioner was created. It seems to us immaterial whether the purpose was to avoid inheritance and transfer taxes or to permit the entire estate of decedent to stand as security for the endowment of the Charity in*1969 which decedent was interested. "What was done, rather than the design and purpose of the participants, should be the test," . If we are mistaken and the purpose is of importance, it may be pertinent to note that this second purpose had been entirely avoided by the time the transaction with which we are dealing took place. The trustees of the estate had convinced the trustees of the Charity that mortgage bonds were as desirable as the debenture bonds issued by petitioner and the Charity had exchanged such debentures. Neither of the purposes mentioned above justified the continued separate existence of petitioner at the time the stock here in question was sold and some other reason must have existed for its continuance. As we have said before, the reason seems immaterial. The fact is that petitioner did have a separate legal existence with privileges and obligations entirely separate from those of its stockholders. The fact that it had only one stockholder seems of no legal significance. *1970 .
Under the facts set forth in our findings of fact we are asked to look through the form to the substance, to disregard the corporate entity and to hold that the estate was in fact the owner of the stock of the British-American Tobacco Co. In support of this contention petitioner relies upon , and . In these cases *1195 the Supreme Court held that taxable income did not result from what they termed in the first case a "paper" and in the second case a "bookkeeping" transaction. Here we have no mere bookkeeping or paper transaction, but the actual transfer of securities and the payment of a debt. The situation is not unlike those presented in , and . In each of those cases it was held that stockholders of a corporation received taxable income although after the transaction the stockholders held the same equities in the same properties as before. In the instant case the*1971 petitioner may have been no richer after the transaction than before, but the same is true of every transaction in which one sells property for its then value. It is because one sells property for more than its cost that a taxable gain results. Here petitioner sold property for more than its cost and after the transaction it had something different from that which it had before. That the transaction was with the estate which owned all its capital stock is not material unless we are not to regard the separate entities of a corporation and its stockholders in transactions between them. That such is not the law seems settled by the cases cited.
Petitioner cites decisions which it is said disregard the separate entities where necessary to prevent fraud or injustice. ; . An analysis of those cases will, we believe, disclose that separate entities were not disregarded. In each of those cases the form of the transaction was not representative of the results accomplished and effect was given to the true situation and not to that depicted by form. Here there is no such case. Securities were sold*1972 at their market value and payment received. The form which the transaction took truly represents the transaction which took place.
The contention that the estate was neither richer nor poorer because of this transaction by reason of the ownership of the stock of petitioner is not new. It has been advanced in different forms to meet different states of facts. Thus, it has been asserted that where upon the dissolution of a corporation the stockholders received its assets in proportion to their stockholdings, no income was realized for the reason that the stockholders were at all time the owners of the assets and thus no richer in the evening than they were in the morning of the day the transaction occurred. This contention was denied in ; ; ; ; and .
Although the estate owned all of petitioner's stock, the transfers involved were made upon the basis of the true value of the securities *1196 exchanged and the debt extinguished*1973 and, therefore, the bona fides of the transaction is not challenged. Neither does this transaction constitute a capital contribution by the estate to petitioner. The estate and petitioner each received full value. The gain of petitioner arises from the sale and exchange of capital assets and is, therefore, taxable income as defined in . See .
Reviewed by the Board.
Decision will be entered for the respondent.