*760 1. The acquisition by the Johnstown Water Corporation of its preferred stock on November 20, 1936, was a partial liquidation of that corporation. The gain derived by petitioners as preferred stockholders is taxable in full.
2. The exchange in 1928 of a part of the common stock (the only stock outstanding) of the Johnstown Water Co. for all of the common stock of the Johnstown Water Corporation, and of the remainder of the Water Co.'s stock for the Water Corporation's preferred stock was a nontaxable transaction made pursuant to a plan of reorganization within the meaning of section 112(b)(3) and (i) of the Revenue Act of 1928.
3. Stock of the G. C. Murphy Co. distributed to certain petitioners by the Hillcrest Foundation, Inc., in 1936 should be taken into consideration in determining gain or loss from distributions by that corporation. A subsequent attack in a court proceeding, still pending, does not affect the status of the stock as a distribution during the taxable year. North American Oil Consolidated v. Burnet,286 U.S. 417">286 U.S. 417, applied.
*1184 The Commissioner determined deficiencies in the income taxes of petitioners as follows:
| Petitioner | Docket No. | Year | Amount |
| Ellene Z. Rosensteel | 101995 | 1936 | $12,532.78 |
| Catherine W. Suppes | 102483 | 1936 | 637.95 |
| Estate of Samuel B. Waters | 102484 | 1936 | 987.55 |
| Mary Ellis Turner | 102676 | 1936 | 9,785.88 |
| Hilda Ellis Mayer | 102677 | 1936 | 10,356.57 |
| Estate of Emma J. Howard | 102822 | 1936 | 7,385.11 |
| Frank Howard | 102823 | 1936 | 41,493.03 |
| 1936 | 1,254.80 | ||
| Alice W. Thomas | 103566 | 1937 | 379.60 |
| 1936 | |||
| 16,173.08 | |||
| Robert S. Waters | 103567 | 1937 | 878.63 |
| Elizabeth W. Waterman | 103568 | 1936 | 4,050.87 |
| Charles W. Kunkle and wife | 103988 | 1936 | 2,026.35 |
Six issues are now in controversy:
1. Was the acquisition of its preferred stock by the Johnstown Water Corporation on November 20, 1936, a partial liquidation, taxable *1185 under section 115(c) of the Revenue Act of 1936, thus rendering the gain therefrom to the preferred stockholders taxable to them in full and not at capital gain rates?
2. Was the exchange in 1928 of a part of the stock of the Johnstown Water*762 Co. for all of the common stock of the Water Corporation and of the remainder of the Water Co. stock for the Water Corporation preferred stock a nontaxable transaction made pursuant to a plan of reorganization within the meaning of section 112(b)(3) and (i) of the Revenue Act of 1928? If so, the basis of the Water Corporation tion preferred stock, for determining gain or loss, was its fair market value at the time of the exchange, or $95 per share.
3. Are the petitioners who exchanged common stock or the Water Co. for preferred stock of the Water Corporation estopped from claiming such basis of $95 per share in computing their gain or loss?
4. Should the stock of the G. C. Murphy Co., distributed to petitioners Alice W. Thomas, Robert S. Waters, and Elizabeth W. Waterman by the Hillcrest Foundation, Inc., be taken into account in determining their gain from the distribution by that corporation?
5. Are petitioners Robert S. Waters and Elizabeth W. Waterman entitled to deduct their investment in the stock of the Century Stove & Manufacturing Co. as having become worthless in 1936?
6. Is petitioner Robert S. Waters estopped from alleging that the stock of the Century*763 Stove & Manufacturing Co. became worthless in 1936?
It is stipulated that petitioner Robert S. Waters is entitled to deduct as worthless in 1937 the amount of his investment in the Johnstown Automobile Co.
FINDINGS OF FACT.
Practically all of the facts were stipulated and as so stipulated we adopt them as our findings of fact. They are substantially as follows:
The individual petitioners resided in Johnstown, Pennsylvania, or its vicinity. The decedents of the fiduciary petitioners also resided in that vicinity and the decedents resided therein at the time of their deaths. The pertinent income tax returns of all the petitioners were filed with the collector of internal revenue for the twenty-third district of Pennsylvania.
The Johnstown Water Co. (hereinafter called the Water Co.) is a Pennsylvania corporation organized in the year 1866 and chartered in that year by special act of the Assembly of the Commonwealth of Pennsylvania. Since its incorporation, and up to and including the present time, it has been engaged in supplying water facilities to the city of Johnstown, Pennsylvania, and the vicinity. On August 8, 1917, the Water Co. acquired all the stock of the*764 Conemaugh & Franklin Water Co., a Pennsylvania corporation engaged in supplying water *1186 facilities to the boroughs of Conemaugh and Franklin, situated adjacent to the city of Johnstown, and since such date and up to the present time has continued to own all of such stock.
On December 1, 1898, and for some time prior thereto, the authorized and outstanding capital stock of the Water Co. consisted of 3,750 shares of common stock of a par value of $100 per share, of which 1,893 shares were owned by the Cambria Iron Co., a Pennsylvania Corporation (hereinafter called Cambria), and 1,857 shares by various other shareholders. In the year 1928 the authorized and outstanding capital stock and the number of shares owned by Cambria remained the same as on December 1, 1898.
On December 1, 1898, Cambria leased all of its property, both tangible and intangible, including its stock in the Water Co., for a period of nine hundred ninety-nine years to the Cambria Steel Co., a Pennsylvania corporation (hereinafter called Cambria Steel). The lease provided, among other things, that Cambria Steel should have the right to vote the Water Co. stock and to receive all dividends thereon. *765 In 1923 the lease was assigned by Cambria Steel to the Bethlehem Steel Products Co., a Pennsylvania corporation, all of the stock of which was owned by the Bethlehem Steel Co., a Pennsylvania corporation (hereinafter called Bethlehem). On July 31, 1935, the lease was assigned by the Bethlehem Steel Products Co. to Bethlehem. On December 21, 1936, the Bethlehem Steel Products Co. was merged into Bethlehem.
On February 9, 1928, an informal meeting of the stockholders of the Water Co. was held, at which a plan proposed by Bethlehem was submitted by H. E. Lewis, the president of the Water Co. The plan provided that a new corporation would be formed with capital stock of 21,000 shares of 6 percent cumulative preferred stock, par value $100 per share, and 21,000 shares of no par value common stock. The preferred stockholders were to be entitled to cumulative 6 percent dividends, payable quarterly before common stock dividends were paid, and, upon dissolution, to payment of the par value of their stock, plus unpaid accumulated dividends thereon. The preferred stock was to be nonvoting and redeemable upon proper notice.
The new company was to acquire all of the outstanding capital*766 stock of the Water Co. by exchanging all of the common stock of the new company for the 1,893 shares of the Water Co. stock controlled by Bethlehem, and by exchanging the preferred stock of the new company for the 1,857 shares of the Water Co. stock owned by others, at the rate of 11 shares of preferred stock for one share of the Water Co. common stock.
On April 19, 1928, the Johnstown Water Corporation (hereinafter called the Water Corporation) was organized under the laws of Delaware. *1187 On April 20, 1928, the Water Corporation made the exchanges of stock precisely as outlined in the foregoing plan except that it exchanged 16,885 shares of its preferred stock for 1,535 shares of the Water Co. stock (including the petitioners' stock). The holders of 322 shares of the Water Co. stock did not make such exchange at that time. On April 20, 1928, the fair market value of the preferred stock of the Water Corporation was $95 per share.
The following table shows the amounts of the net earnings of the Water Corporation and the amounts paid to its preferred stockholders during each of the years from April 19, 1928, to October 31, 1936, inclusive:
| Year | Net earnings | Dividends paid on preferred stock |
| Apr. 19 to Dec. 31, 1928 | $10,695 | $51,282 |
| 1929 | 25,601 | 102,564 |
| 1930 | 25,756 | 102,564 |
| 1931 | 26,440 | 108,240 |
| 1932 | 27,609 | 108,240 |
| 1933 | $23,566 | $108,240 |
| 1934 | 29,470 | 108,240 |
| 1935 | 27,470 | 108,240 |
| Jan. 1 to Oct. 31, 1936 | None | 81,180 |
| Total | 196,607 | 878,790 |
*767 The amounts necessary to make such payments to the preferred stockholders during the years from April 19, 1928, to October 31, 1936, were lent to the Water Corporation by Bethlehem. No interest was charged to or paid by the Water Corporation on loans so made. During this period certain amounts were repaid by the Water Corporation to Bethlehem. The amounts so lent during each of these years by Bethlehem for such purposes and the amounts repaid by the Water Corporation to Bethlehem were as follows:
| Year | Loans by Bethlehem | Repayments by Water Corporation to Bethlehem |
| Apr. 19 to Dec. 31, 1928 | $55,641 | $13,000 |
| 1929 | 100,500 | 22,500 |
| 1930 | 101,500 | 24,000 |
| ,1931 | 106,000 | 25,000 |
| 1932 | 104,000 | 26,000 |
| 1933 | $108,000 | $25,000 |
| 1934 | 94,000 | 10,000 |
| 1935 | 104,000 | 25,000 |
| Jan. 1 to Oct. 31, 1936 | 94,000 | 22,000 |
| Total | 867,641 | 192,500 |
On September 18, 1936, the board of directors of the Water Corporation adopted a resolution to redeem on November 20, 1936, its outstanding 6 percent cumulative preferred stock (18,040 shares) at $105 per share, plus any accumulated unpaid dividends, and authorized the treasurer of the Water Corporation to borrow from Bethlehem*768 such funds as might be required for the purpose.
Pursuant to such resolution of its board of directors the Water Corporation borrowed from Bethlehem the sum of $1,926,874.77, the total *1188 amount of the redemption price of the outstanding 18,040 shares of preferred stock at $105, plus the amount necessary for payment of accumulated unpaid dividends to November 20, 1936. At the time the sum was borrowed from Bethlehem the Water Corporation did not have funds with which to acquire its outstanding preferred stock. As of November 1, 1936, the Water Corporation was indebted to Bethlehem for loans theretofore made in the total amount of $2,791,820.04, computed as follows:
| Total amounts loaned by Bethlehem for payment of dividends to Water Corporation preferred stockholders | $867,641.00 |
| Payments made by Bethlehem to others for account of Water Corporation: | |
| For capital stock of Water Co. purchased | 189,645.80 |
| For taxes | 150.00 |
| For other expenses | 8.47 |
| Loaned for redemption of preferred stock | 1,926,874.77 |
| Total | 2,984,320.04 |
| Less: Repayments by Water Corporation | 192,500.00 |
| 2,791,820.04 |
On September 19, 1936, the Water Corporation addressed to its*769 preferred stockholders a notice of redemption of its 6 percent cumulative preferred stock. On November 20, 1936, preferred stockholders owning 15,605 shares of the outstanding 18,040 shares surrendered their certificates and received therefor from the Water Corporation the sum of $105 per share, or a total of $1,638,525. On or before December 15, 1936, the balance of the preferred certificates were surrendered and the stockholders received therefor the sum of $105 per share, or a total of $255,675, making a total of $1,894,200 paid by the Water Corporation in redeeming all of its outstanding preferred stock.
On December 15, 1936, the Water Corporation filed with the Secretary of State of the State of Delaware a certificate of redemption of 6 percent cumulative preferred stock. The certificate recited that the Water Corporation had redeemed the outstanding 18,040 shares of its 6 percent cumulative preferred stock at $105; that the certificate of incorporation did not prohibit the reissue of the shares of the preferred stock so redeemed, and that the certificate was made in order that, upon its filing and recordation, the capital of the corporation should be deemed to be and should*770 thereby be reduced by the amount of the par value of the redeemed stock, or $1,804,000.
On December 17, 1936, the board of directors of the Water Corporation adopted a resolution declaring that its certificate of incorporation be amended to provide for the issuance of 20,000 shares of preferred stock of no par value and 21,000 shares of common stock of no par *1189 value. The preferred stock carried dividends of $6 per share and was noncumulative, the dividends thereon to be paid out of the net profits of the corporation. Upon liquidation the preferred and common stock were to share the distributable assets retably. The indebtedness of $2,791,820.04, due by the Water Corporation to Bethlehem, was to be liquidated by issuing 19,980 shares of its preferred stock to that company. On the same day the stockholders of the Water Corporation unanimously approved and adopted the proposed amendment to the certificate of incorporation. On December 21, 1936, a certificate of amendment to the certificate of incorporation was filed with the Secretary of State of Delaware.
On December 28, 1936, the Water Corporation's board of directors authorized the issuance of 19,980 shares of*771 its preferred stock to Bethlehem in satisfaction of its debt of $2,791,820.04 to that company. On December 31, 1936, the Water Corporation issued 19,980 such shares to Bethlehem and the debt thereupon was canceled.
The petitioners owned various blocks of capital stock of the Water Co. and also of the preferred stock of the Water Corporation, as more fully appears from the stipulation, to which reference is here specifically made for a complete record of the amounts of the stock held by the petitioners and the history of their acquisition by the petitioners and their redemption by the Water Corporation.
In their income tax returns for the year 1936 all the petitioners, except Mary Ellis Turner, Hilda Ellis Mayer, and Elizabeth W. Waterman, reported as income, taxable on a capital gain basis, the gains arising from the redemption of their 6 percent cumulative preferred stock of the Water Corporation heretofore set forth. Petitioners Mary Ellis Turner, Hilda Ellis Mayer, and Elizabeth W. Waterman reported no taxable gain at all from the redemption of their stock.
In determining deficiencies in the income taxes of the petitioners for the year 1936, the respondent reduced the*772 basis of their preferred stock in the Water Corporation by a substantial portion of distributions theretofore made by the Water Corporation which he determined were made from capital. He also held that the acquisition by the Water Corporation of its preferred stock was a partial liquidation fo the corporation, the gain from which was taxable in full under section 115(c) of the Revenue Act of 1936.
Petitioners Alice W. Thomas, Robert S. Waters, and Elizabeth W. Waterman each owned, in the years 1935, 1936, and 1937 and prior thereto, 60 shares of the common stock of the Hillcrest Foundation, Inc., a Pennsylvania corporation, having a basis in the hands of each amounting to $79,597.72.
During the years 1935, 1936, and 1937 the Hillcrest Foundation, Inc., made certain distributions not out of earnings to its stockholders. The *1190 following table shows the date and the amount of the distributions and the proportionate share received by each of the petitioners:
| Date paid | Distributions | Each petitioner's proportionate share |
| Dec. 6, 1935 | Cash, $3,500 | $777.78 |
| Nov. 2, 1936 | 4,965 shares of common stock of G. C. Murphy Co. having a fair market value of $70.50 per share, or a total of $350,032.50 | 77,785.00 |
| Nov. 2, 1936 | $48,000 par value city of Miami refunding bonds of 1964 having an aggregate fair market value of $41,700 | 9,266.67 |
| Dec. 13, 1937 | Cash, $9,800 | 2,177.78 |
*773 The 4,965 shares of the common stock of the G. C. Murphy Co. distributed by the Hillcrest Foundation, Inc., on November 2, 1936, were received on February 19, 1936, in exchange for 1,655 shares of the same stock held prior thereto by the Hillcrest Foundation, Inc., pursuant to a stock split-up on the basis of three shares of common stock for one. The said 1,655 shares of G. C. Murphy Co. common stock were acquired by the Hillcrest Foundation, Inc., on October 31, 1934, as a contribution to capital by the heirs of John H. Waters, who in turn acquired these shares by inheritance from John H. Waters, who died intestate on August 14, 1933. The three petitioners are heirs of John H. Waters. Each of them received a two-ninth interest in his estate. Alice M. Waters, the mother of the petitioners, received the remaining one-third interest.
On November 14, 1938, a bill of complaint was filed in the Court of Common Pleas of Cambria County, Pennsylvania, by the executors of the will of William R. Thomas, deceased, against the administrator of the estate of John H. Waters, deceased, the Hillcrest Foundation, Inc., Alice M. Waters, Robert S. Waters, Elizabeth W. Waterman, Alice W. Thomas*774 and the G. C. Murphy Co., alleging that William R. Thomas during his lifetime was the owner of the 1,655 shares of G. C. Murphy Co. common stock; that these shares were pledged to John H. Waters as security for certain obligations of William R. Thomas; that after the death of John H. Waters the obligations, together with the G. C.Murphy Co. stock held as collateral, came into the possession of Robert S. Waters as administrator of the estate of John H. Waters; that Robert S. Waters transferred the shares, with the obligations they secured, to the Hillcrest Foundation, Inc.; and that the Hillcrest Foundation, Inc., transferred them to the four heirs of John H. Waters, deceased.
The plaintiffs prayed, inter alia, that the defendants (other than the G. C. Murphy Co.) account for the income, issues, and profits of the stock, submit a statement of the balance due on the obligations of William R. Thomas in order that these obligations might be paid in full, and turn over to the plaintiffs all the stock of the G. C. Murphy *1191 Co. held as collateral security for the obligations of William R. Thomas.
In their answer to the bill of complaint the defendants in the proceeding*775 (other than G. C. Murphy Co.) averred, inter alia, that, because of the failure of William R. Thomas to pay his indebtedness to John H. Waters, the shares of stock of the G. C.Murphy Co. were sold on October 28, 1931, at private sale to John H. Waters, and John H. Waters became the owner thereof free from any right of redemption on the part of William R. Thomas.
As of August 12, 1940, the Court of Common Pleas of Cambria County entered a decree dismissing the bill of complaint. On appeal by the plaintiffs the Supreme Court of Pennsylvania on March 24, 1941, filed an opinion reversing the decree of the Court of Common Pleas, reinstating the bill of complaint, and remitting the record for further proceedings consistent with its opinion. The matter is now pending before the Court of Common Pleas on remand from the Supreme Court of Pennsylvania.
In their returns for the years 1936 and 1937 none of the petitioners, Alice W. Thomas, Robert S. Waters, and Elizabeth W. Waterman, included any gain resulting from the said distributions by Hillcrest Foundation, Inc. In determining deficiencies of each of these petitioners for the years 1936 and 1937 the Commissioner included in income*776 as capital gains the amounts by which the cash and fair market values of the securities distributed to each of them by Hillcrest Foundation, Inc., exceeded the basis of each in that corporation's stock.
In the year 1936 and for some time prior thereto petitioners Robert S. Waters and Elizabeth W. Waterman were the respective owners of 30 shares and 15 shares of the common stock of the Century Stove & Manufacturing Co. (hereinafter called Century), which had been acquired by them at a cost of $2,410.65 and $1,500, respectively.
The principal business of Century, which was incorporated in Pennsylvania on May 2, 1902, consisted of the manufacture and sale of gas ranges, gas heaters, and other gas appliances. During the years 1935 and 1936 its outstanding capital stock consisted of 1,500 shares of common stock of a par value of $100 per share. During the year 1934 it applied for a loan of $30,000 from the Reconstruction Finance Corporation and the application was approved and the loan was made on October 17, 1934, secured by mortgage on all the lands, buildings, and equipment of Century.
On June 5, 1935, William B. Waters & Bro., Inc., and William B. Waters, as plaintiffs, filed*777 an application in the Court of Common Pleas of Cambria County for the appointment of a receiver for Century, and on June 10, 1935, the court entered an order appointing a *1192 receiver and authorizing and empowering him to continue the operations of the business for a period of six months.
The following is a balance sheet as of June 5, 1935, as per the books of Century.
| Assets | Liabilities | ||
| Cash | $3,159.41 | Accounts payable | $18,133.62 |
| Notes receivable | 4,725.00 | Bills and notes payable | 80,023.90 |
| Accounts receivable | 13,796.56 | Mortgage | 30,000.00 |
| Stocks of other corporations | 11,407.18 | Taxes payable | 1,546.60 |
| Inventory | 30,795.98 | Interest payable | 1,132.66 |
| Unexpired insurance | 579.09 | Total liabilities | 130,836.78 |
| Land, building, machinery and | |||
| equipment (less depreciation | |||
| reserve) | 121,368.81 | Capital stock - common | 150,000.00 |
| Total assets | 185,832.03 | Deficit | 95,004.75 |
On August 20, 1935, the board of directors of Century approved a plan of reorganization to be submitted to creditors and stockholders for acceptance. The plan recited the financial condition of the company and required that the corporation be reorganized under*778 the same name, that the Reconstruction Finance Corporation note (amounting to $30,234.99) be secured by first mortgage, that 8,646 shares of noncumulative preferred stock (par value $86,460) and 3,429.2 shares of no par value common stock (book value $39,663.84) be issued and that cash in the sum of $8,008.53 be paid on priority and other claims.
The plan provided further that unsecured creditors having claims of less than $50 be paid in cash; that all other unsecured creditors receive 50 percent of the face amount of their claims in the proposed preferred stock at par value, plus 1 share of common stock for each 5 shares of preferred stock; that certain payroll and tax claims be paid in cash; that the holders of common stock of the old company receive 1 share of the proposed common stock for 3 shares of the old stock held by them, and that 4,000 additional shares of preferred stock and 2,000 additional shares of common stock be sold at $10 and $1 per share, respectively.
On October 30, 1935, a petition to convene creditors was filed and November 18, 1935, was fixed as the day on which the plan should be submitted to the creditors and stockholders. No quorum was present on the*779 designated day and the meeting was continued to December 2, 1935. On that day a petition was filed by one of the plaintiffs stating that the business had showed some improvement and praying that the receivership be continued for three months. The petition was granted.
On November 9, 1935, the Reconstruction Finance Corporation petitioned the court for a rule to show cause why it should not be allowed to have judgment confessed on the obligation of $30,000 of Century, *1193 and to show cause why foreclosure proceedings should not be commenced. On November 27, 1935, the rule was made absolute.
On January 21, 1936, the property securing the aforesaid note in the face amount of $30,000, due the Reconstruction Finance Corporation, was levied upon; and on February 15, 1936, the property was sold at sheriff's sale to the highest bidder, the Reconstruction Finance Corporation, for the sum of $25. On January 30, 1936, the receiver filed a petition praying for an order to sell the inventory, accounts receivable, and other personal property of Century in his possession and the prayer was granted on the same date. On February 18, 1936, the inventory, accounts receivable and other*780 personal property were sold at public sale for $4,750. On February 19, 1936, the sale was confirmed by the court. The stockholders of Century received no part of the proceeds of the sale. On April 6, 1936, the first and final account of the receiver was filed with the court and on September 24, 1936, the receiver was discharged.
In his income tax return for the year 1936 petitioner Robert S. Waters claimed a deduction of $2,410.65 on account of alleged worthlessness of stock of Century. The respondent disallowed such deduction on the ground that the stock became worthless in the year 1935. Thereupon Waters filed a claim for refund based upon the determination of the Commissioner that the stock became worthless during the year 1935. The refund claim was allowed in the amount of $602.66, and a Treasury check in the amount of $721.56, which included interest of $113.21, was issued to Robert S. Waters, who cashed it and received the proceeds thereof. On April 9, 1940, the collector of internal revenue advised Robert S. Waters by mail that he was holding such check in the above amount. On April 13, 1940, the counsel for Robert S. Waters delivered a letter to the collector stating, *781 among other things, that the acceptance of the check was not an admission of the correctness of the deduction for the year 1935. He thereupon received the check from the collector and transmitted it to Robert S. Waters.
Petitioner Elizabeth W. Waterman filed a nontaxable return for the year 1935, in which no deduction was claimed on account of the worthlessness of the Century stock. In her 1936 income tax return she deducted the sum of $1,500, representing the cost of the shares of stock, on the ground that those shares became worthless in the year 1936. The respondent has disallowed the deduction on the ground that the shares became worthless in the year 1935.
In the year 1937 petitioner Robert S. Waters was the owner of ten shares of the stock of the Johnstown Automobile Co., which he had acquired on September 26, 1919, at a cost of $1,000. The stock became wholly worthless and the cost thereof was deductible in the year 1937. In his return for the calendar year 1937 the petitioner failed to deduct *1194 any amount on account of the loss sustained because of the worthlessness of his Johnstown Automobile Co. stock and the respondent has allowed as a deduction no*782 amount on account of such loss for the year 1937.
The following additional facts are disclosed by the record:
The plan to issue new preferred stock to Bethlehem in discharge of the Water Corporation's indebtedness was formed shortly after the old stock was called for redemption and a considerable time before the Water Corporation acquired its 6 percent cumulative preferred stock from its stockholders and was adopted to protect the equity of Cambria, the owner of all of the Water Corporation's common stock, against any possible prior claims of creditors of the Water Corporation. This was in accordance with the desire of directors of Cambria who had theretofore expressed dissatisfaction with the plan which the Water Corporation had adopted of borrowing amounts necessary to pay annual dividends on its preferred stock, since such procedure tended to jeopardize Cambria's interest as a stockholder.
OPINION.
VAN FOSSAN: The first issue presents the question whether or not the redemption of the petitioners' preferred stock in the Water Corporation on November 20, 1936, constituted a partial liquidation taxable under section 115(c) of the Revenue Act of 1936. 2
*783 The petitioners assert and attempt to show that the entire procedure, starting with the resolution of the board of directors of the Water Corporation on September 18, 1936, to redeem the outstanding $100 par value 6 percent cumulative preferred stock of the corporation on November 20, 1936, and ending with the issue on December 31, 1936, of 19,980 of its new noncumulative no par value preferred stock to Bethlehem, was one entire unified plan whose purpose was to *1195 purchase the old preferred stock and to "resell" to Bethlehem the preferred interest in the corporation in the form of a somewhat similar stock, with no concomitant intent to distribute in complete cancellation or redemption of a part of the Water Corporation stock.
The petitioners argue that "as a whole" the transaction took nothing from the Water Corporation and transferred none of the corporate assets to its stockholders. They recite that before the redemption of the petitioners' 6 percent cumulative preferred stock the Water Corporation had outstanding 18,040 shares of such stock, while after the issuance of the 6 percent noncumulative preferred stock the corporation had outstanding 19,980 shares of the*784 latter stock, a substitute "with some change in the character of the interest", and assert also that the net worth of the Water Corporation was increased by this maneuver.
The respondent contends that the Water Corporation intended to redeem the preferred stock of the petitioners and others as a complete integral action, and sets forth the following evidentiary facts:
On September 19, 1936, the Water Corporation sent to the preferred stockholders its notice of redemption. On November 20, 1936, the corporation redeemed a portion of the stock in cash and completed the redemption by December 15, 1936. On December 15, 1936, the corporation filed a certificate of redemption with the Secretary of State of Delaware, stating that the certificate was filed so that its capital might be deemed to be reduced by the face value of the redeemed stock, or $1,804,000, pursuant to the requirement of the law of Delaware. On December 17, 1936, the Water Corporation stockholders adopted a resolution altering its structure by eliminating therefrom the authorized issue of 6 percent cumulative preferred stock at $100 a share and permitting the issue of noncumulative preferred stock of no par value*785 carrying dividends of $6 per share. On December 21, 1936, a corresponding certificate of amendment was filed with the Secretary of State of Delaware. The corporation made appropriate entries on its books indicating the retirement of the stock. Each petitioner received $105 per share, the redemption price specified in the charter. The 19,980 shares of the new stock were issued to Bethlehem on December 31, 1936.
The respondent maintains that from an analysis of this record, the shift of the parties in interest, and the wide variance in the character of the preferred stocks, the indubitable conclusion must be drawn that the redemption of the petitioners' preferred stock was a wholly separate transaction from the issuance of the new preferred stock to Bethlehem.
The respondent has overlooked one fact contained in the record which strongly supports his position. Robert E. McMath (vice *1196 president of Bethlehem and president of the Water Corporation), under whose supervision the transactions described were accomplished, testified that the Water Corporation borrowed from Bethlehem the funds needed to redeem the old stock; that the loan and other indebtedness of the Water*786 Corporation to Bethlehem were discharged by an issue of a new class of preferred stock at the end of 1936, and that the plan for the redemption by the issuance of the preferred stock originated "shortly after the old stock was called for redemption and sometime before November 14, 1936."
This bit of testimony clarifies the facts and clearly leads to the conclusion that the creation of the new stock and its issuance to Bethlehem and the redemption of the petitioners' preferred stock were not parts of a single integrated plan, but were separate transactions. The procedure of redemption pursued precisely its original and independent course, which terminated in the filing of the required certificate with the Secretary of State of Delaware, stating that the Water Corporation had redeemed all of its outstanding 6 percent cumulative preferred stock at its authorized redemption price and that the certificate was made "in order that * * * the capital * * * shall be deemed to be and shall thereby be reduced by the amount of the capital of the Corporation so applied to the aforesaid redemption of said 18,040 shares of said Six Per Cent Cumulative Stock to wit, $1,804,000.00."
Although the*787 stock could have been reissued, the purport of the certificate was that a reduction of capital and not a reissuance of the stock was contemplated by means of the process of redemption. Moreover, reissuance was effectively barred by the subsequent amendment to the certificate of incorporation.
We have no doubt, on the facts and in the light of decided cases, that the redemption of the 6 percent cumulative preferred stock by the Water Corporation constituted a partial liquidation within the purview of section 115(c) and as defined by section 115(i). See ; ; .
The later issuance of the 6 percent noncumulative preferred stock was accomplished by a separate and independent series of actions and events. The expedient was adopted to protect the equity of Cambria, holder of the common stock, against the potential pressure of Bethlehem's claims as a common creditor and became the more imperative after the Water Corporation had borrowed almost two million dollars from Bethlehem to pay for the redeemed stock of the*788 petitioners and others.
Furthermore, the authorization and the issuance of the new stock were begun after the redemption of the old stock and the proper certification thereof were completed. There was no overlapping such *1197 as normally would have occurred if both transactions had been component parts of a single plan. This sharp separation of record and procedure is additionally persuasive that there was no definite unified plan to substitute the new 6 percent noncumulative preferred stock for the old 6 percent cumulative preferred stock. See . On the issue here involved we sustain the respondent.
In the second issue we must determine whether or not the exchange of common stock in the Water Co. for common and preferred stock of the Water Corporation was a taxable transaction.
The petitioners concede that under a strictly literal interpretation of the pertinent statutory provisions (sec. 112(b)(3) and (i), Revenue Act of 1928 3 ) the exchange was nontaxable, but argue that the transferor of stock must retain a proprietary interest in the enterprise in order to meet the requirements of the statute, *789 citing . They assert that the preferred stock which they received in the transaction represented no such interest.
*790 In the Le Tulle case the Supreme Court said:
* * * Where the consideration is wholly in the transferee's bonds, or part cash and part such bonds, we think it cannot be said that the transferor retains any proprietary interest in the enterprise. On the contrary, he becomes a creditor of the transferee; and we do not think that the fact referred to by the Circuit Court of Appeals, that the bonds were secured solely by the assets transferred and that, upon default, the bondholder would retake only the property sold, changes his status from that of a creditor to one having a proprietary stake, within the purview of the statute.
Thus the Court distinguished between the character of a bond and that of preferred stock. The petitioners were either stockholders and as such the owners of a proprietary interest in the enterprise *1198 (the Water Corporation), or were its creditors. In Black's Law Dictionary, p. 1449, the word "proprietary" is defined as "relating or pertaining to ownership, belonging or pertaining to a single individual owner." The right of management is only one of the powers incident to ownership and that power may be waived or delegated. Restrictions, *791 voluntary or otherwise, of ownership do not change the inherent character of the right. A creditor is defined as a person to whom a debt is owing by another person, called a debtor. Black's Law Dictionary, p. 476.
Petitioners possessed no debt due from or claim against the Water Corporation. They owned an interest in the corporation. They could not proceed against it to recover their investment in the preferred stock so long as none of their specified rights were violated but the creditors could enforce their claims in the customary legal manner.
The distinction between a creditor and a stockholder of a corporation is too clearly defined to merit much discussion. The status of a holder of preferred stock, as compared with that of the owner of common stock, is set forth in Fletcher Encyclopedia of Corporations, Permanent Ed., vol. II, sec. 5290, as follows:
In the absence of special provisions, the holders of preferred stock in a corporation are in precisely the same position, both with respect to the corporation itself and with respect to creditors of the corporation, as the holders of common stock, except only that they are entitled to receive dividends on*792 their shares, to the extent guaranteed or agreed upon, before any dividends can be paid to the holders of common stock.
In , the court said:
The general rule is that a holder of preferred stock, even though the preferred dividend is guaranteed, is not regarded as a creditor of the corporation, and entitled as such to share with the other creditors in the distribution of the assets. He is, like the holders of the common stock, merely a stockholder, but with this difference, that he is entitled to priority of payment out of the assets which remain after all debts are paid; the holders of the common stock sharing in such assets as are left.
In the case at bar the petitioners had all the rights usually reserved to preferred stockholders but lacked only the right to vote. For the purposes of section 112 we believe that the absence of this privilege is immaterial to the issue. It certainly can not convert a stockholder into a creditor.
The cases cited by both the petitioners and the respondent are useful only in an analogical discussion in which we deem it unnecessary to indulge. We hold that*793 the exchange of the Water Co. stock in 1928 for the Water Corporation stock constituted a nontaxable transaction within the meaning of section 112(b)(3) and (i) and that, consequently, the basis of gain or loss to the petitioners upon *1199 the redemption of their Water Corporation stock in 1936 was the cost of the Water Co. stock to them.
In view of our decision in the second issue the question presented in the third issue becomes moot.
The fourth issue involves the propriety of including the G. C. Murphy stock in the distribution of the Hillcrest Foundation, Inc., to petitioners Alice W. Thomas, Robert S. Waters, and Elizabeth W. Waterman in 1936 and 1937. The circumstances surrounding the transfer of the stock are fully set forth in the findings of fact and need not be repeated.
Both the petitioners and the respondent cite and rely on . In that case the Court said:
* * * If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to*794 retain the money, and even though he may still be adjudged liable to restore its equivalent.
We think the principles so announced apply to the facts before us. Certain individuals acquired the G. C. Murphy Co. stock by inheritance in 1933 from the estate of John H. Waters, who, prior to his death, claimed to have acquired it by purchase in 1931. The stock was contributed as capital to the Hillcrest Foundation, Inc., in 1934 and the shares, increased by a stock split-up, were distributed to the petitioners in 1936; all under the same "claim of right" and "without restriction as to disposition." At that time no litigation was pending. There is no element of trusteeship or agency in the situation that would exclude the gain from the petitioners' own income tax liability. See ; ; . The deferment of taxation, pending the final outcome of litigation, later initiated, would distort the taxation of current income within the intendment of the tax statutes.
Therefore, the distribution of the G. *795 C. Murphy Co. stock must be taken into account in determining the gain to the petitioners arising from the distributions made by the Hillcrest Foundation, Inc., during the years 1936 and 1937.
The fifth issue requires us to determine whether the stock of the Century Co. became worthless in 1936 or at some time before that year. Century was incorporated in 1902. The record does not show what degree of prosperity it enjoyed for the ensuing 32 years, but in 1934 it obtained a loan of $30,000 from the Reconstruction Finance Corporation. Apparently at that time its business prospects were considered fairly good. In June 1935 a receiver was appointed for the company. The balance sheet of June 5, 1935, reflects the unsatisfactory *1200 condition of the enterprise. In August 1935 a plan of reorganization was proposed whereby the claims of creditors would be adjusted by a cash and stock settlement. In October 1935 a petition to convene creditors was filed. On December 2, 1935, one of the plaintiffs in the receivership proceeding reported that the business showed some improvement and requested a continuance of the receivership for three months. The court thereupon granted*796 the request.
In the meantime the Reconstruction Finance Corporation had taken steps to perfect its preferred rights by seeking a confessed judgment and the authority to foreclose. The affairs of Century remained in suspension until January 21, 1936, when its property securing the Reconstruction Finance Corporation obligation was levied on. On February 15, 1936, the property was sold to the Reconstruction Finance Corporation for a nominal sum. On January 30, 1936, the receiver requested authority to sell Century's remaining assets and on February 18, 1936, sold them for $4,750.
From this review of the essential facts we see that as late as December 2, 1935, a plaintiff in the receivership action declared to the court that Century's business was improving and asked that the receivership be continued. Obviously, at that time there was no indication that the stock was worthless even though the Reconstruction Finance Corporation had obtained an absolute rule to foreclose. The establishment and continuation of the receivership does not impute worthlessness. *797 . Until sale there always was a chance to complete the reorganization plan and to satisfy the Reconstruction Finance CorporationS demands. Even at that sale the stockholders and creditors might have paid for the buildings and equipment enough to pay off or curtail the Reconstruction Finance Corporation loan and so to continue Century's business operations.
Of course, the sale to the Reconstruction Finance Corporation at $25 merely indicates that no one was willing to pay for the mortgaged property more than the debt against it. Consequently, the forced sale of Century's remaining assets did not measure their real worth to a going concern.
From all the facts here presented we conclude that the petitioners' stock in Century had some potential value in 1935 and that such value was not extinguished until 1936. , affd., .
In the sixth issue the respondent asserts that petitioner Robert S. Waters is estopped from alleging that his Century stock was worthless in 1936. In an amendment to his answer the respondent raised this issue on the ground that the petitioner*798 claimed a deduction in his income tax return for the year 1936 based on the worthlessness of his Century stock; that the respondent disallowed the deduction on the *1201 ground that the stock became worthless in 1935; that thereupon the petitioner filed a claim for refund; that hid claim was allowed by the respondent; and that the petitioner received and cashed a Treasury check representing that allowance. In his pleadings the respondent does not state that the claim for refund related to the year 1935, but we may assume that to be the situation.
The stipulated facts show that on April 9, 1940, the collector of internal revenue notified the petitioner that he was holding the Treasury check covering the refund. On April 13, 1940, the petitioner, through counsel, notified the collector that the acceptance of the check did not constitute an admission of the correctness of the deduction for the year 1935.
In his brief the respondent does not argue the point, but only cites ; affd., *799 ; certiorari denied, . The purport of that decision is that "honesty, good faith and consistency are due in tax accounting" and that "the right and wrong of things and equitable principles have a place in tax matters."
The decision in the Alamo case is neither controlling nor persuasive on the issue before us. Here, the petitioner was not guilty of dishonesty, bad faith, or inconsistency. On the contrary, he claimed that his Century stock became worthless in 1936. The respondent's action prevented the allowance of the deduction for that year. The petitioner then, in conformity with the respondent's determination, filed a claim for refund. The claim was allowed and a check issued therefor, but before accepting it the petitioner reiterated his original position and specifically stated that he did not concede the correctness of the respondent's action.
Under these circumstances we find no grounds on which the respondent can maintain his position on this question. He could not have been misled. If he ultimately should fail to recover the item or its equivalent in income he can blame only himself. The plea of estoppel*800 is rejected.
Decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Catherine W. Suppes; Estate of Samuel B. Waters, deceased, Catherine Suppes, Executrix; Mary Ellis Turner; Hilda Ellis Mayer; Estate of Emma J. Howard, deceased, Charles F. Hager, Administrator c.t.a.; Frank Howard; Alice W. Thomas; Robert S. Waters; Elizabeth W. Waterman; and Charles W. Kunkle and Maude B. Kunkle, husband and wife. ↩
2. SEC. 115. DISTRIBUTIONS BY CORPORATION.
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(c) DISTRIBUTIONS IN LIQUIDATION. - Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 111, but shall be recognized only to the extent provided in section 112. Despite the provisions of section 117(a), 100 per centum of the gain so recognized shall be taken into account in computing net income, except in the case of amounts distributed in complete liquidation of a corporation. For the purpose of the preceding sentence, "complete liquidation" includes any one of a series of distributions made by a corporation in complete cancellation or redemption of all of its stock in accordance with a bona fide plan of liquidation and under which the transfer of the property under the liquidation is to be completed within a time specified in the plan, not exceeding two years from the close of the taxable year during which is made the first of the series of distributions under the plan. In the case of amounts distributed (whether before January 1, 1934, or on or after such date) in partial liquidation (other than a distribution within the provisions of subsection (h) of this section of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account not be considered a distribution of earnings or profits. ↩
3. SEC. 112. RECOGNITION OF GAIN OR LOSS.
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(b) EXCHANGES SOLELY IN KIND. -
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(3) STOCK FOR STOCK ON REORGANIZATION. - No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
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(i) DEFINITION OF REORGANIZATION. - As used in this section and sections 113 and 115 -
(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority 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 substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
(2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation. ↩