*1851 A corporation having first and second preferred stock and common stock made a 25 per cent reduction in its issued outstanding second preferred stock and simultaneously amended its charter, changing its authorized issue of common stock of 10,000 shares, of par value of $100 each, to 10,000 shares, without par value. At that time, there were 19 holders of second preferred stock of whom, including petitioners, seven were directors who owned all the outstanding (35) shares of common stock, each director owning five shares thereof. When the 25 per cent reduction in second preferred stock was made by surrender of such stock to the company and the cancellation thereof by it, the holders of both second preferred and common stock received 200 shares of the no par value stock in the place of each share held of the common stock of the par value of $100 each. No change was made in the first preferred stock and none was owned by either of petitioners. The common stock constituted all the voting stock of the company before and after the change to common stock of no par value, held as stated, and thereafter there was no change in the personnel of the second preferred stockholders or their proportionate*1852 interest in the second preferred stock. Held:
(1) In the circumstances of the instant case, the transactions described worked a recapitalization and constituted a reorganization within the meaning of section 203(h)(1) of theRevenue Act of 1924.
(2) No loss was sustained by the petitioners and the determination of the Commissioner is approved.
*433 The Commissioner determined deficiencies in income tax for the calendar year 1924 against Benjamin W. Fredericks and Sedgwick Kistler, in the respective amounts of $1,079.69 and $1,955.70.
The deficiencies are due to the failure of the Commissioner to allow as deductions for the year 1924 alleged losses claimed to have been sustained by reason of the surrender by the petitioners in that year of 25 per cent of their holdings of second preferred stock in the Kistler Leather Co., a Delaware corporation.
The cases are consolidated for hearing and decision and are submitted on admissions in respondent's answers, testimony of one witness, stipulation of certain facts, *1853 and an exhibit.
*434 FINDINGS OF FACT.
The petitioners are individuals, Benjamin W. Fredericks residing in Boston, Mass., and Sedgwick Kistler residing at Lock Haven, Pa.
Each of said petitioners on or about January 1, 1918, purchased second preferred stock of the Kistler Leather Co., paying therefor $100 a share, the par value of the stock, Benjamin W. Fredericks so purchasing 13,250 shares and Sedgwick Kistler, 23,500 shares.
This second preferred stock was entitled to cumulative dividends at the rate of 6 per cent per annum and in case of liquidation the participation of this stock in the assets of the company was limited to such unpaid and cumulative dividends and $100 a share. In the event of liquidation, the first preferred stockholders would be entitled to all unpaid accrued dividends on said stock, and $100 per share; thereafter the second preferred stockholders would be similarly entitled; any remaining assets would be divided ratably among the holders of common stock.
On or about the 19th day of December, 1924, pursuant to action of the stockholders and directors of Kistler Leather Co., a Delaware corporation, a reduction of the issued outstanding second*1854 preferred stock of said company was duly made to the extent of 25 per cent of such outstanding second preferred stock.
At the date of the reduction in the issued second preferred stock, there were issued and outstanding, of first preferred stock of the Kistler Leather Co., 8,800 shares of a par value of $880,000. No change was made in this class of stock and none of this stock was owned by either of the petitioners. There were issued and outstanding of second preferred stock, at the time of the reduction, a total of 41,020 shares of the total aggregate par value of $4,102,000. At the time of said reduction of second preferred stock, there were issued and outstanding 35 shares of the common stock, out of a total authorized 10,000 shares of common stock, of a par value of $100 each. Each of the petitioners owned five shares of this common stock. Simultaneously with the reduction of second preferred stock, the charter of the company was amended, changing the authorized common stock of the company to 10,000 shares without par value, and each of the common stockholders received 200 shares of this no-par stock in lieu of each share of the old stock, of the par value of $100, each*1855 of the petitioners by this exchange receiving 1,000 shares of the new common stock without par value.
In a stipulation between counsel of the taxpayer and the Commissioner, it is recited: "In accordance with the terms of the reduction of the second preferred stock, each holder of second preferred, without consideration, surrendered 25 per cent of his holdings of said stock." This stock was canceled by the company. The 25 per cent *435 surrendered by the petitioner Fredericks amounted to 3,295 shares. The stock so surrendered by the petitioner Kistler amounted to 5,510 shares. The stock of both said petitioners was so surrendered on or about December 31, 1924. The stock of each of the petitioners surrendered as aforesaid cost him $100 a share in the year 1918.
The stipulation above referred to also contained the following statement: "There was no agreement or arrangement or understanding between either of the petitioners and the Company whereby the petitioners should ever receive from the Company any direct consideration for stock so surrendered, and the petitioners have never received any such direct consideration."
The percentage of interest of the petitioner Fredericks*1856 in said second preferred stock of the company issued and outstanding at the time of his surrender of 25 per cent of his holdings was 32.1 per cent, and that of the petitioner Kistler was 53.7 per cent. The percentage of interest of each of said petitioners after the surrender of said shares as respects the second preferred stock continued the same as previous to surrender.
The percentage of interest of each of the petitioners in the outstanding common stock of the company at the time of the surrender of the second preferred stock was 14.2 per cent and the percentage of interest of each in the common stock outstanding continued to be 14.2 per cent of said outstanding common stock after such surrender of second preferred stock.
At the date of the surrender of the second preferred stock there were 19 holders of said second preferred stock, of whom 7 were directors. The outstanding 35 shares of common stock were all owned by the said directors, including the petitioners, each person owning 5 shares. The said common stock constituted all the voting stock of the company and continued to do so after the surrender of second preferred stock and the increase in the number of shares*1857 of common stock and the change of said common stock to no par value.
After the reduction of the second preferred stock the same 19 stockholders who had held the second preferred stock prior to the reduction continued to hold the second preferred stock. There was no change in the personnel of the second preferred stockholders or in the amounts of their holdings. They continued to hold the same proportionate interest in the second preferred stock as before.
On December 31, 1924, the total assets of the Kistler Leather Co. had a book value of $8,546,135.07, with total liabilities of all kinds, including the first preferred stock of the company of the par value of $880,000 and accrued dividends on same of $198,000, amounting to $5,269,360.10, leaving an asset book value of $3,276,774.97 to apply on the 41,020 shares of second preferred Kistler Leather Co. stock *436 outstanding just prior to the reduction of same in December, 1924, as heretofore stated.
The deficit existing in the assets of the Kistler Leather Co. prior to the reduction of the second preferred stock was wiped out by such reduction and a surplus of $200,274.97 created on the books of the company, without*1858 the payment of any money or the addition of anything in the way of assets.
OPINION.
SEAWELL: It is stated in behalf of the petitioners that neither this Board nor the courts have rendered any decision on the issue raised by the facts of this case.
In this instance, as in numerous others, the directors and stockholders of the Kistler Leather Co. deemed it advisable to eliminate an existing deficit in order to present a better financial aspect of the corporate business. With a view to accomplishing such result, the second preferred stockholders, of whom there were nineteen, seven being directors, of whom petitioners were two, pursuant to action of the stockholders and directors of the company voluntarily surrendered 25 per cent of their holdings of second preferred stock, which stock was canceled by the company. In one part of the stipulation by counsel it is recited that this was done "without consideration," but in a subsequent paragraph, indicating - as we view it - what was meant by such expression, it is stated: "There was no agreement or arrangement or understanding between either of the petitioners and the Company whereby the petitioners should ever receive from the*1859 Company any direct consideration for stock so surrendered, and the petitioners have never received any such direct consideration."
The use of the word "direct" twice, in the latter paragraph, was evidently intended to explain and qualify the meaning of the expression "without consideration" previously used. When construed together they simply mean there was never any direct or express consideration received for such action nor any agreement that there would ever be any such consideration received.
At the date of the reduction in the second preferred stock no change was made in the first preferred stock, none of which was owned by either of the petitioners. There were then outstanding 35 shares of the common stock, of which the petitioners and five other directors each owned five shares.
Simultaneously with the reduction of the second preferred stock the charter of the company was amended, authorizing the issuance of 10,000 shares of common stock, without par value, and each of the holders of common stock received 200 shares of this no-par stock *437 in lieu of each share held of the old stock of the par value of $100. Each of the petitioners by this exchange received*1860 1,000 shares of the new common stock without par value.
The percentage of interest of each of the petitioners in both the outstanding second preferred stock and the outstanding common stock of the company was the same after as before the surrender of the second preferred stock and there was then no change in the personnel of the second preferred stockholders and they continued to hold the same proportionate interest in the second preferred stock.
If the surrender by the petitioners of 25 per cent of their second preferred stock be considered merely as a gift, no deductible loss for same is allowable under the Revenue Act of 1924.
The contention of the petitioners, however, is that the second preferred stockholders substantially changed their asset preferences when they surrendered 25 per cent of their second preferred stock; that by so doing their shares were worth 25 per cent less than previous to their voluntary relinquishment of that percentage of the stock they held; and that at that time, by such surrender of second preferred stock, they sustained a loss for which they could never receive any sum to make up the loss so suffered.
It is further insisted that the deficit*1861 existing on the books of the Kistler Leather Co. was passed directly to the second preferred stockholders by the action taken in the surrender and cancellation of 25 per cent of their second preferred stock and that such constituted a closed transaction. We do not so view matters.
It is true that the second preferred stock was limited to cumulative dividends at the rate of 6 per cent per annum and in case of liquidation participation in the assets of the company was limited to such unpaid and cumulative dividends and $100 a share. In our opinion, the surrender by petitioners of 25 per cent of their second preferred stock and the cancellation of the same did not necessarily entail any actual loss upon them at that time nor could it then be determined that they would ever sustain a loss by reason of their action.
The financial status of the Kistler Leather Co. was such that it was deemed best, from a business point of view, to wipe out a deficit appearing on its books, and the reason for the action taken in surrendering by stockholders of 25 per cent of second preferred stock held by them to effect such result was evidently based on their best judgment and furnished sufficient*1862 consideration for such action, and in consequence thereof the corporation was put in better business position and the holders of common stock, of whom petitioners were two, each, as a direct result of the plan evolved and adopted, received *438 1,000 shares of no-par-value stock for the five par-value shares previously held.
The surrender of the second preferred stock for cancellation did not result in changing the proportionate interest of the petitioners in the second preferred stock outstanding.
The actual asset value in the aggregate of the second preferred holdings before surrender and after surrender was the same.
The Kistler Leather Co. made a 25 per cent reduction in its second preferred stock, the holders of the same surrendering such to the company, which canceled it. It amended its charter, changing its authorized issue of common stock of 10,000 shares, of par value of $100 each, to 10,000 shares, without par value. The 35 shares of outstanding common stock of par value of $100 each before the charter amendment were after such amendment surrendered to the company and in place thereof 7,000 shares of no par value were issued to the holders of the former. *1863 Such transactions, in our opinion, worked such a recapitalization as constituted a reorganization within the meaning of section 203(h)(1) of the Revenue Act of 1924.
In , in construing section 202(c)(2) of the Revenue Act of 1921, we held:
* * * The mere surrender to a corporation of certain shares of preferred stock to be canceled, with nothing to be received from the corporation in exchange therefor, is not a reorganization within the meaning of section 202(c)(2).
Of course, in making this statement we do not mean to hold that a recapitalization under a proper state of circumstances may not be a reorganization. For example, if corporation A has an outstanding capital stock of $100,000 represented by 1,000 shares of common stock of $100 par value per share, and decides to reduce its capital stock to $50,000, to be represented by 500 shares of common stock of a par value of $100 each, and provides that each stockholder shall receive in exchange one share for each two shares now held, we think that would undoubtedly be a reorganization because there would be the exchange contemplated by section 202(c)(2) and*1864 in such transaction no gain or loss would be recognized.
In the instant case, the same principle and reasoning are applicable in construing section 203(h)(1) of the Revenue Act of 1924. See also .
We are of the opinion, as heretofore indicated, that the evidence shows the Kistler Leather Co. effected a reorganization within the meaning of section 203(h)(1) of the Revenue Act of 1924 and, therefore, in the circumstances of the instant case, the petitioners sustained no loss and the respondent's determination is approved.
Reviewed by the Board.
Judgment will be entered for the respondent.
*439 MURDOCK, concurring: I concur in the result reached in this case for reasons set forth in my dissenting opinion in the case of , and also on authority of .
LANSDON dissents.