*21 Decision will be entered for the respondent.
The taxpayer corporation was formed and acquired assets of an insolvent predecessor pursuant to a reorganization plan carried out under section 77-B of the Bankruptcy Act. It issued shares and first mortgage bonds which were sold for cash and second mortgage bonds which were exchanged for the predecessor's first mortgage bonds of equal face value. The predecessor's stockholders received nothing.
(1) The predecessor's transfer of assets to the taxpayer, held, not a transaction on which no gain or loss was recognizable within the intendment of section 112 (b) (10), Internal Revenue Code, because there was no continuity of interest on the part of owners of the enterprise prior to the reorganization. Section 29.112 (b) (10)-1, Regulations 111, approved.
(2) The taxpayer's basis for the assets acquired from the predecessor, held, the cost of such assets to it, not to the predecessor.
*890 Respondent determined deficiencies in excess profits tax for the fiscal years ended September 30, 1944, and September 30, 1945, in the respective amounts of $ 13,158.08 and $ 1,004.96 and in income tax for the fiscal year ended September 30, 1945, in the amount of $ 15,537.89.
In petitioner's income and excess profits tax returns for the fiscal year ended September 30, 1944, petitioner used its asserted cost of its assets in computing its basis for depreciation and equity invested capital*23 purposes, without regard to the basis of such assets in the hands of its predecessor, Chicago Stadium Corporation, an Illinois corporation organized June 5, 1928, hereinafter referred to as the "Illinois corporation."
In petitioner's income and excess profits tax returns for the fiscal year ended September 30, 1945, in computing its basis for purposes of depreciation and equity invested capital, petitioner used the asserted basis of the assets in the hands of the Illinois corporation. Petitioner concedes it erred in computing its equity invested capital by using in the returns as the cost of the land to the Illinois corporation an amount of $ 1,063,506.31 in excess of the correct cost to the Illinois corporation.
In the notice of deficiency for the taxable years here at issue respondent determined that petitioner's basis for depreciation and equity invested capital purposes of the property involved herein was not the basis of the property in the hands of the Illinois corporation, and held that petitioner's basis was the cost of such assets to petitioner.
Petitioner concedes the correctness of the following adjustments determined by respondent in the notice of deficiency: Fiscal year*24 ended September 30, 1944 -- adjustment (a), "taxes" disallowed in the amount of $ 3,766.10; fiscal year ended September 30, 1945 -- adjustment (b), "taxes" disallowed in the amount of $ 1,308.32; and adjustment (c) "maintenance" disallowed in the amount of $ 1,465.30.
The sole issue remaining for decision is, Is the basis of petitioner's assets for depreciation and equity invested capital purposes the cost of the assets to petitioner, as determined by respondent, or is petitioner entitled to use the basis of a prior corporation under sections 112 (b) (10) and 113 (a) (22) of the Internal Revenue Code, as amended?
The facts were stipulated.
FINDINGS OF FACT.
Petitioner is a corporation, organized and existing under the laws of the State of Delaware, with its principal office in Chicago, Illinois. *891 Its returns for the years involved were filed with the collector of internal revenue for the first district of Illinois.
The Chicago Stadium is a large fireproof indoor arena in Chicago, Illinois, constructed for the Chicago Stadium Corporation, an Illinois corporation, organized June 5, 1928, referred to in our opening statement and hereinafter as the "Illinois corporation." The*25 Illinois corporation defaulted in its interest payment of January 1, 1932, on its first mortgage bonds, and on January 20, 1933, temporary receivers were appointed by the District Court of the United States for the Northern District of Illinois, Eastern Division. A mortgage foreclosure proceeding, instituted the same day, was consolidated with the receivership proceeding. The receivers were made permanent on February 8, 1933. They continued operations by leasing the building.
On June 25, 1934, a petition was filed in the United States District Court for the Northern District of Illinois, Eastern Division, to reorganize the Illinois corporation, under section 77-B of the Bankruptcy Act, being Case No. 56337 in bankruptcy. On August 6, 1934, an order was entered by the United States District Court for the Northern District of Illinois, Eastern Division, appointing the foregoing receiver as trustee in the bankruptcy proceeding, and immediately the property and assets of the Illinois corporation were transferred from the receiver to the trustee in bankruptcy.
On October 18, 1934, a petition to intervene in the reorganization proceedings was filed by a first mortgage bondholders' protective*26 committee, which presented to the court a "Plan and Agreement for Reorganization," dated August 22, 1934. The plan contemplated the formation of a new corporation to acquire the property, and estimated that $ 250,000 in cash would be required for the payment of taxes and reorganization expenses and to provide working capital. As part of the plan the underwriter, James Norris, agreed to and did supply the amount of $ 250,000 in cash to provide for taxes, working capital, and reorganization expenses, in consideration of the issuance to him of $ 250,000 of first mortgage bonds of the new corporation. It was also agreed that the underwriter would purchase all of the common stock of the new corporation for the further payment of $ 1,000 in cash.
Claims were filed in the reorganization proceeding in September and October, 1934, on behalf of holders of $ 1,679,000 face amount of the first mortgage bonds, $ 210,000 face amount of the second mortgage bonds, 18,437 shares of preferred stock, and 378,532 shares of common stock. Other claims, aggregating $ 103,279.09, were also filed.
The court appointed a special master, who after a number of hearings filed a report including an appraisal*27 of the chattels and personal property of the Illinois corporation at $ 10,384.04 as of November 20, *892 1934, and an appraisal of the land, buildings, and fixtures at a "fair value" of $ 1,700,000 as of December 6, 1934. The land, buildings, and fixtures aforesaid constituted the property subject to the lien of the first mortgage made by the Illinois corporation. On February 25, 1935, the court entered a decree confirming and approving the plan of reorganization, with amendments not here material.
The petitioner, the Chicago Stadium Corporation, was incorporated in the State of Delaware on February 28, 1935, as Chicago Indoor Stadium Corporation (name changed to Chicago Stadium Corporation on August 27, 1935), and is the new corporation contemplated in the plan of reorganization. The petitioner was organized to acquire the assets of the Illinois corporation pursuant to the decree of February 25, 1935. Pursuant to the decree of February 25, 1935, the trustee transferred on March 12, 1935, and March 13, 1935, to petitioner most of the property except for certain personal property, which was later transferred. Other property, not subject to mortgage, was later sold under order*28 of the court, the proceeds going to general creditors.
The authorized and outstanding capitalization of the Illinois corporation was as follows:
| 6 per cent first mortgage bonds | $ 1,679,000 | |
| 7 per cent second mortgage bonds | 185,100 | |
| Preferred stock ($ 100 par value) | 2,495,000 | |
| Common stock (no par value) | shares | 500,000 |
The authorized and outstanding capitalization of petitioner was as follows:
| 5 per cent first mortgage bonds | $ 250,000 | |
| 5 per cent second mortgage bonds | 1,679,000 | |
| Common stock (no par value) | shares | 1,000 |
Pursuant to the plan of reorganization and the decree of February 25, 1935, the foregoing stock and bonds of petitioner were issued as follows:
(a) 1,000 shares of its common stock were sold to an underwriter, James Norris, for $ 1,000 in cash.
(b) 5 per cent first mortgage bonds in the face amount of $ 250,000 were sold to James Norris for $ 250,000 in cash.
(c) 5 per cent second mortgage bonds in the face amount of $ 1,679,000 were issued to holders of $ 1,679,000 face amount of the 6 per cent first mortgage bonds of the Illinois corporation.
The holders of the preferred and common stock of the Illinois corporation received none of the*29 stock or bonds issued by petitioner, and received none of the proceeds from the sale of those assets of the Illinois corporation which were sold. The interests of such stockholders in the Illinois corporation were completely eliminated under the plan of reorganization and pursuant to the plan of reorganization *893 such stockholders received no interests in petitioner.
The basis to the Illinois corporation for the properties involved herein, as of March 13, 1935, was land, $ 820,090.26; building and all other property, $ 2,870,939.20.
The basis of petitioner's assets for depreciation and equity invested capital purposes is as determined by respondent in the notice of deficiency, predicated upon the cost thereof to petitioner.
OPINION.
Petitioner's position is that the transaction by which it acquired its assets from Chicago Stadium Corporation (Illinois) constitute a "reorganization" under section 112 (b) (10), Internal Revenue Code, 1*31 and that accordingly the basis of those assets is the basis in the hands of the Illinois corporation under section 113 (a) (22). 2 Respondent determined that the transaction did not constitute a "reorganization" under section 112 (b) (10) and*30 that therefore the basis of petitioner's assets should be predicated upon their cost to petitioner. Respondent's argument is that the continuity of interest in the business on "the part of those persons who were the owners of the enterprise prior to the reorganization" required by Regulations 111, section 29.112 (b) (10)-1, 3 is lacking here. Respondent *894 also maintains that the transaction does not meet the specific statutory requirement of section 112 (b) (10) that the property of the old corporation be transferred to the new corporation "in exchange solely for stock or securities" of the new corporation.
*32 Dealing with respondent's second contention first, we think that, contrary to that contention, the transaction here in question is not barred from the coverage of section 112 (b) (10) by reason of the "solely for stock or securities" statutory requirement just cited. Section 112 (d) of the code specifically provides:
(d) Same -- Gain of Corporation. -- If an exchange would be within the provisions of subsection (b) (4) or (10) of this section if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then --
(1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange, but
(2) If the corporation receiving such other property or money does not distribute it in pursuance of the plan of reorganization, the gain, if any, to the corporation shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property so received, which is not so distributed.
*33 Here, land, buildings, and fixtures which had been subject to the lien of the first mortgage made by the old Illinois corporation were transferred to petitioner, the new corporation. The first mortgage bondholders, who, as in Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179">315 U.S. 179, may be treated as having become owners of the equity in the insolvent corporation from the date of the institution of bankruptcy proceedings, received in exchange for their first mortgage bonds second mortgage bonds of petitioner. To be sure, other property of the old corporation, not subject to mortgage, was exchanged for cash or other property than stock or securities in the new corporation. But under section 112 (d) the tax-free character of the insolvency reorganization is not destroyed in such case -- assuming, of course, that this is otherwise a tax-free insolvency reorganization under section 112 (b) (10).
However, as already stated, respondent's primary argument is that the transaction here in question does not qualify as a reorganization under section 112 (b) (10) because it does not meet the "continuity of interest" requirement of Regulations 111, section*34 29.112 (b) (10)-1, cited above. Petitioner does not seriously dispute that that requirement is not met, and the facts could support no other conclusion. Here, as stated in our findings, the owners of the enterprise prior to the "reorganization," the stockholders of the old Illinois corporation, holding both preferred and common stock in the amounts of $ 2,495,000 and $ 500,000, acquired none of the stock or bonds issued by petitioner, and received none of the proceeds from the sale of those assets *895 of the Illinois corporation which were sold. The interests of such stockholders in the Illinois corporation were completely eliminated under the plan of reorganization and pursuant to the plan of reorganization such stockholders received no interest in petitioner. The entire issue of common stock of petitioner was sold instead to the underwriter, James Norris, for cash. Norris also purchased for cash the entire issue of first mortgage bonds of petitioner in the amount of $ 250,000. Nor did the holders of first mortgage bonds of the Illinois corporation, who, as we have said, may be treated as having become the owners of the equity in the insolvent corporation, receive any*35 stock interest in petitioner. They received in exchange for their first mortgage bonds of the old corporation only second mortgage bonds of petitioner, thus becoming merely creditors of petitioner. Thus it is plain that the requirement of Regulations 111, section 29.112 (b) (10), that, in order to "qualify a transaction as a reorganization under section 112 (b) (10)" there be "a continuity of interest therein on the part of those persons who were the owners of the enterprise prior to the reorganization," is not met here.
Petitioner, however, bases its appeal from respondent's determination almost entirely upon an assault upon Regulations 111, section 29.112 (b) (10)-1, contending that the regulation, in so far as it purports to require a continuity of interest as between predecessor and successor corporations, is not a proper interpretation of section 112(b) (10). We do not agree. The Senate Finance Committee Report on the Revenue Bill of 1943, S. Rept. No. 627, specifically says (p. 50) concerning section 112 (b) (10), which was first introduced with that bill:
* * * It is intended that only an actual reorganization of a corporation will be covered as distinguished from a liquidation*36 in a bankruptcy proceeding and sale of property to either new or old interests supplying new capital and discharging the obligations of the old corporation. In other words, the type of transaction which was held not to be a reorganization under section 112 (g) (1) in the Mascot Stove Co. case (120 F. (2d) 153) or in Templeton's Jewelers, Inc. (126 F. (2d) 251) would likewise not be covered under these amendments. * * *
In Mascot Stove Co. v. Commissioner (C. C. A., 6th Cir., 1941), 120 Fed. (2d) 153, cited in the committee report, the stockholders in the old company, which had become bankrupt, were permitted to become stockholders in the new company, but it was held that the requisite continuity of interest was lacking, and that the stockholders did not receive an interest in the acquiring corporation in exchange for their interest in the transferor, since by virtue of the adjudication in bankruptcy the old stockholders had nothing to transfer. Here, the stockholders of the Illinois corporation had nothing to transfer, could receive nothing, and were not even permitted to become stockholders*37 *896 in the new company. Hence, the absence of the requisite continuity is even more striking than in the Mascot Stove Co. case.
In Templeton's Jewelers, Inc. v. United States (C. C. A., 6th Cir., 1942), 126 Fed. (2d) 251, also cited in the committee report, the old corporation made an assignment of all of its property to a trustee for the benefit of creditors. The business was then operated temporarily by the president-majority stockholder, who borrowed sufficient money to complete a settlement with the creditors and thereafter acquired the assets from the assignee and transferred them to a new corporation. The new corporation assumed the debts of the old corporation to the nonconsenting creditors and employee-claimants of the old company received an insignificant amount of stock in the new company. Most of the stock was issued to the majority stockholder of the old corporation. The court followed the principles of the Mascot Stove Co. case, and noted that "90 per cent of the creditors were eliminated by the settlement made with new capital, and the remaining 10 per cent except for labor claimants in negligible amount, acquired*38 no proprietary interest in the new corporation." In the case before us it is clear that there was a sale of property to new interests supplying new capital, the stockholders of the old company were eliminated, as were the second mortgage bondholders, and the first mortgage bondholders acquired no proprietary interest in the new corporation.
It is plain that both the Mascot Stove Co. and Templeton's Jewelers, Inc., cases determined that the transactions involved did not constitute "reorganizations" primarily because the required continuity of interest was lacking, and that under the reasoning of those cases the transaction here involved similarly does not constitute a reorganization. The fact that those cases were cited by the Senate Finance Committee in its report, plus the language of that report as quoted above, can lead us to no other conclusion than that it was the legislative intent to include continuity of interest between predecessor and successor corporations as a requirement for a reorganization under section 112 (b) (10). Accordingly, Regulations 111, section 29.112 (b) (10)-1, in so far as it requires that continuity of interest, is entirely valid, and the transaction*39 here in question, failing to meet this requirement, does not qualify as a reorganization under section 112 (b) (10). Therefore we have found as a fact that the basis of petitioner's assets for depreciation and equity invested capital purposes is as determined by respondent in the notice of deficiency, predicated upon the cost thereof to petitioner.
Decision will be entered for the respondent.
Footnotes
1. SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * * *
(b) Exchanges Solely in Kind. --
* * * *
(10) Gain or loss not recognized on reorganization of corporations in certain receivership and bankruptcy proceedings. -- No gain or loss shall be recognized if property of a corporation (other than a railroad corporation, as defined in section 77m of the National Bankruptcy Act, as amended) is transferred, in a taxable year of such corporation beginning after December 31, 1933, in pursuance of an order of the court having jurisdiction of such corporation --
(A) in a receivership, foreclosure, or similar proceeding, or
(B) in a proceeding under section 77B or Chapter X of the National Bankruptcy Act, as amended,↩
to another corporation organized or made use of to effectuate a plan of reorganization approved by the court in such proceeding, in exchange solely for stock or securities in such other corporation.2. SEC. 113. ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS.
(a) Basis (Unadjusted) of Property. -- The basis of property shall be the cost of such property; except that --
* * * *
(22) Property acquired on reorganization of certain corporations. -- If the property was acquired by a corporation upon a transfer to which section 112 (b) (10)↩ * * * is applicable, then, * * * the basis in the hands of the acquiring corporation shall be the same as it would be in the hands of the corporation whose property was so acquired * * *.
3. SEC. 29.112 (b) (10)-1. * * *
* * * *
As used in section 112 (b) (10), the term "reorganization" is not controlled by the definition of "reorganization" contained in section 112 (g). However, certain basic requirements, implicit in the statute, which are essential to a reorganization under section 112 (g), are likewise essential to qualify a transaction as a reorganization under section 112 (b) (10)↩. Among these requirements are a continuity of the business enterprise under the modified corporate form and a continuity of interest therein on the part of those persons who were the owners of the enterprise prior to the reorganization. * * *