*1074 1. Taxpayer in 1936 made a sale of British corporation shares which in 1930 it had acquired with other assets and rights in a conglomerate exchange for 360,000 of its own shares, which was then treated as tax-free under section 112(b)(5), Revenue Act of 1928, with a resulting basis to taxpayer of transferor's original cost of $1,000,000. Taxpayer now claims that the 1930 transaction was not tax-free, that it is not required to use transferor's basis, and that its own basis is its actual cost at acquisition, which is greater than transferor's basis. Held that, even though the 1930 transaction were not tax-free and petitioner be entitled to use its own cost as basis, evidence does not establish that in fact such cost is greater than the $1,000,000 used.
2. The cost of specific assets acquired as part of a conglomerate group of assets and rights in exchange for 360,000 shares issued for all is not established by opinion evidence as to the value when thus acquired of only the specific assets the cost of which is in question.
3. Contemporaneously with the sale to BP of British corporation shares, the taxpayer redeemed some of its outstanding preferred shares, which were*1075 owned by the banker who negotiated the sale to BP, and used some of the proceeds of the sale for the redemption. Held, the sale and the redemption were separate and may not be regarded as an exchange so as to reduce the amount of gain from the sale.
4. In an accrual method of accounting, capital stock tax for 1935-1936 was, in accordance with established practice, accrued in 1935 upon a low declared value and deducted on the 1935 income tax return. In 1936, upon a higher declared value, and additional amount as 1935-1936 capital stock tax, together with the entire capital stock tax for 1936-1937, was deducted on the 1936 income tax return. Held, the capital stock tax for 1935-1936 may not be split and no part is deductible in 1936.
5. In an accrual method of accounting, an income tax deduction for 1937 of capital stock tax of 1937-1938 is limited to the correct capital stock tax upon the declared value finally used, even though a greater amount based upon a higher declared value has been provisionally accrued on the taxpayer's books.
6. An amount paid by a corporation in redemption of shares while some of the same class of shares were not redeemed, is a preferential*1076 dividend and not the proper subject of a dividends paid credit. After the redemption, however, a dividend upon the entire remaining shares is not preferential and is a proper credit.
Neither the correspondence relating to the redemption of shares nor the terms of the preferred shares is, upon the evidence, a contract expressly prohibiting the payment of dividends.
7. The surrender by a shareholder of part of his shares to enable the corporation to transfer them to creditors for their acquisecence in another transaction, the shareholder receiving nothing, is not a sale or exchange of capital assets. The loss upon such disposition is deductible to the full extent and is not subject to the limitation of $2,000 applicable to capital losses.
*738 The Commissioner determined deficiencies of $631,006.24 and $25,296.31 in petitioner's income taxes for 1936 and 1937, respectively. For 1936, petitioner assails (1) the use of the transferor's cost as its own basis for computation of gain, *1077 and (2) the treatment of the transaction as a sale and not as in part an exchange; (3) petitioner demands a deduction for Pennsylvania taxes; (4) petitioner demands a larger deduction for Federal capital stock tax for 1936; (5) respondent demands a disallowance of deduction for capital stock tax for 1937; (6) petitioner demands a greater undistributed profits tax credit for 1936; and (7) petitioner demands a full loss deduction upon shares surrendered instead of the $2,000 allowed by the Commissioner as upon a capital loss.
*739 Many of the facts are stipulated and may be regarded as found in the language of the stipulations.
FINDINGS OF FACT.
Petitioner, a Delaware corporation with principal office at Philadelphia, Pennsylvania, filed its income tax returns for 1936 and 1937 in the first district of Pennsylvania. It was organized on August 7, 1930, pursuant to the terms of an agreement dated April 24, 1930, between the Edward G. Budd Manufacturing Co. (herein called the Manufacturing Co.), J. Henry Schroder & Co., a London banking house (herein called Schroder), and the J. Henry Schroder Banking Corporation, of New York. The purpose of the agreement was to turn over*1078 to a new corporation, the petitioner, the entire European interests and business of the Anufacturing Co. in a manner enabling the transferee to secure funds for the conduct of that business and for liquidation of an indebtedness of Ambi-Budd Presswerk (herein called Ambi-Budd), in which the Manufacturing Co. owned shares.
The Manufacturing Co. was organized as a Pennsylvania corporation in 1912, and has since engaged in the manufacture of railroad rolling stock and of all-steel bodies for automobiles. It developed and improved the all-steel body, protecting its manufacturing processes and product by United States and foreign patents. In 1924 it granted a nonexclusive license to Citroen for the manufacture of allsteel bodies in France, and under the license it was receiving royalties of $10,000 a month in 1926, and $20,000 a month in 1929. In 1926 it granted an exclusive license for Germany and a number of small countries in Europe and Asia to Ambi-Budd, a newly organized German corporation, which engaged in the manufacture of automobile bodies in Germany. During 1926 it organized the "Pressed Steel Company of Great Britain, Limited" (herein called Pressed Steel), granted to*1079 it a 99-year exclusive license for the use of the processes and patents in the manufacture of all-steel bodies in the British Isles, and sent to England the manufacturing machinery and a staff of technical experts for production organization and the training of English managers and workmen. Of Pressed Steel's capital stock the Manufacturing Co. acquired 64 percent of the common shares, consisting of 20,900 class A and 17,500 class B, each of a par value of Pound10, at a cost of $1,000,000, and it also, by subscription, acquired 1,000 preference shares of a par value of Pound 100 each. Of the subscription price of Pound 100,000 it paid only Pound 70,000 (equivalent to $344,458.01). Schroder acquired all the rest of Pressed Steel's shares: 21,600 class A common and 5,000 preference.
On September 19, 1930, as contemplated by the agreement of April 24, 1930, petitioner made agreements with the Manufacturing Co. pursuant to which the Manufacturing Co. sold, assigned, and transferred *740 to petitioner the folowing property, constituting a small part of its assets:
(1) 38,400 common and 1,000 preference shares of Pressed Steel;
(2) 50.59% (RM 1,019,000) of the outstanding*1080 common shares of Ambi-Budd;
(3) Royalties and other benefits to become due under the license contracts with Citroen, Ambi-Budd and Pressed Steel, which the Manufacturing Co. agreed not to modify or terminate;
(4) All assets of the Manufacturing Co. in Europe, (which comprised all the European patent rights).
The Manufacturing Co. further promised to assign petitioner licenses for the use of future patents and processes of body manufacture; to give advice and information on operation; to furnish petitioner with funds to pay the dividends on preferred shares in case its earnings should be insufficient, and to guarantee that payment; to subscribe and pay for 3,428 more preferred and 3,428 more common shares if petitioner should be required to pay the additional Pound 30 a share on the price of its Pressed Steel preference shares.
The petitioner issued 360,000 common shares to the Manufacturing Co.; promised to pay to it $344,458.01 (the amount which had been paid by the Manufacturing Co. on the price of the 1,000 preference shares of Pressed Steel), and to assume the obligation for the balance of Pound 30 a share.
Simultaneously and pursuant to the agreements, the Manufacturing*1081 Co. subscribed for 76,572 preferred and 76,572 common shares of petitioner's stock for $3,350.025, and Schroder, having previously agreed to take over 68,572 shares of each class, paid $3,000,025 to the Manufacturing Co., which immediately paid this amount, together with $350,000 to petitioner. Thereupon petitioner paid the Manufacturing Co. "$350,000 cash in accordance with the above promise." (The promise was to pay $344,458.01.) Petitioner then issued 76,572 preferred and 76,572 common shares to the Manufacturing Co., which simultaneously transferred 68,572 of each to Schroder. After the consummation of these transactions the Manufacturing Co. held 8,000, or 10.45 percent, of petitioner's preferred shares and 368,000, or 84.29 percent, of its common shares; Schroder held the remainder, 68,572 preferred and 68,572 common.
On its books petitioner entered the assets received by it from the Manufacturing Co. as follows:
| 7% Cumulative Participating Preference Shares of Pressed Steel Co. Ltd. (1000 shares of Pound100 par value each, less 30% uncalled; Ordinary Shares of Pressed Steel Co. Ltd. (38400 shares of Pound 10 par value each) | $2,350,000.00 |
| Common Capital Stock of Ambi-Budd Presswerk | 500,000.00 |
| Patents and Process Rights, Contracts and Goodwill as valued by Board of Directors as at date of acquisition | 1,800,000.00 |
| $4,650,000.00 |
*1082 *741 Entries in its capital stock account were as follows:
| Shares | Stated value | |
| $3.50 cumulative convertible preferred stock, no par value | 80,000 | $3,500,000.00 |
| Common Stock, no par value, authorized | 600,000 | |
| Reserve for conversion of preferred stock | 160,000 | |
| 440,000 | 4,100,000.00 | |
| $7,600,000.00 | ||
| Together | ||
| Unissued 3,428 units each of 1 share preferred stock and 1 share common stock - subscription price | 149,975.00 | |
| $7,450,025.00 | ||
| Surplus | $200,000.00 |
In 1935 Pressed Steel reduced the par value of all its shares to Pound 1; its shares were thereafter held as follows:
| Common shares | Percent | Preference shares | Percent | |
| Petitioner | 332,595 | 57.79 | 81,667 | 16.7 |
| Schroder | 242,975 | 42.21 | 408,333 | 83.3 |
| Total | 575,570 | 100 | 490,000 | 100 |
In January 1936 Pressed Steel reduced the par value of its common shares to 5 shillings, and each shareholder became entitled to receive four new shares for each Pound 1 share held.
When petitioner was organized in 1930. its authorized capital stock was 80,000 cumulative preferred shares and 600,000 common shares, all without par value. Each preferred share outstanding*1083 was convertible at the holder's option into two common shares, and for fulfillment of this obligation 160,000 of the authorized common shares were reserved. By petitioner's amended certificate of incorporation, holders of preferred shares were entitled to receive out of surplus or net profits "cumulative dividends at the rate of $3.50 per annum and no more * * * before any dividend shall be paid or set apart upon the common stock." Preferred shares were subject to redemption on notice $52at a share plus accrued dividends, and a sinking fund was required for that purpose in which petitioner should place each year an amount equal to 3 percent of the largest number of preferred shares which had ever been outstanding. Holders of preferred shares were not entitled to vote at shareholders' meetings unless preferred dividends in the amount of $3.50 a share should be in arrears; if the arrearage should be $7 a share, they were empowered to demand resignation of officers, directors, and executive committeemen, sufficient *742 in number to permit them to elect majorities. While preferred shares were outstanding, petitioner was forbidden to reduce its earned surplus by any disposition*1084 to common shareholders below the lesser of (a) $120,000 and (b) net profits for 1930 and 1931, remaining after payment of preferred dividends. The consent of holders of twothirds of the preferred shares was necessary for:
(c) The declaration or payment of any dividend (other than in common stock) to the holders of common stock or any distribution of its assets to the holders of common stock or the purchase, retirement or other acquisition of any common stock except out of the earned surplus or net profits of the corporation remaining after first making good any impairment in the capital and paid-in surplus of the corporation, as determined in accordance with sound accounting practice.
These and other charter provisions relating to preferred shares were printed on the back of the share certificates, and remained in force until the preferred shares were retired and canceled in 1936.
During 1930, with the proceeds of the issuance of preferred shares, petitioner purchased the following from Ambi-Budd:
| Cost | |
| Ambi-Budd 7% gold note for $1,675,000 | $1,606,370.40 |
| Ambi-Budd 8% cumulative preferred shares, RM 5,000,000 | 1,258,641.60 |
| Ambi-Budd common shares, RM 304,000 (final payment March 1934) | 76,576.80 |
*1085 Because of its poor financial condition Ambi-Budd was recapitalized in March 1934, and in the execution of the plan petitioner delivered to it the above note and shares, other common shares carried on petitioner's books at $500,000, and accrued royalties of $11,111.62 - all having to petitioner a cost of $3,452,700.42. In exchange therefor petitioner received common capital stock (RM 3,626,962) of Ambi-Budd, which it "recorded on its books as having a then value of not more than $863,942, and thereby recorded as a loss the sum of $2,588,758.42." This amount was neither claimed nor allowed as a deduction in the computation of petitioner's income tax for 1934.
Prior to the recapitalization of Ambi-Budd and in January 1934, petitioner reduced its stated common capital stock from $4,100,000 to $1,320,000, crediting the difference of $2,780,000 to paid-in surplus, which was thereby increased from $200,000 to $2,980,000. At the same time its books indicated a deficit of $76,006.97 in earned surplus. Against this paid-in surplus petitioner charged the $2,588,758.42 and the $35,877.27 organization expenses, leaving a paid-in surplus of $355,364.31. Its capital stock account was then*1086 $4,670,025 instead of $7,450,025, as it had been at the beginning of the year.
Prior to 1936 petitioner paid no devidend on its common shares. It never created the sinking fund required for redemption of the preferred shares. Preferred dividends of $469,003.50 were paid for the period October 1, 1930, to June 30, 1932; of this amount the *743 Manufacturing Co. paid $281,107.43 in fulfillment of its obligation under the agreement of September 19, 1930. Preferred dividends remained unpaid thereafter, and to the end of 1935 were in arrears in the amount of $12.25 a share.
The Manufacturing Co. pledged its shares of petitioner as collateral for a loan from the Federal Reserve Bank, agreeing that any distributions on the pledged shares should be applied in curtailment of the loan. To procure funds for curtailment a financial agent was employed on October 15, 1935, to raise funds by disposition of foreign holdings. He was to receive expenses and be paid a commission. He made trips to Europe for this purpose, but found it impossible to sell the licensing contracts or Ambi-Budd shares and was confronted with legal restrictions against the transfer of funds out of Germany*1087 and other European countries. He then approached Schroder in London on the subject of a disposition of petitioner's Pressed Steel shares in some manner which would yield the needed cash. During the course of negotiations, Schroder insisted on the retirement of its shares of petitioner's preferred as a condition of any trade with it. Schroder interested the British Pacific Trust, Ltd., in a purchase of Pressed Steel common shares. On December 12, 1935, petitioner paid the British Pacific Trust, Ltd., Pound 16,629/15/0 for an option or "put" giving petitioner the right to demand that British Pacific buy its 332,595 Pressed Steel common at Pound 3/7/6. About the same time, petitioner advised the Bank of England of the proposed plan and received the British Treasury's consent to the transactions contemplated.
During January 1936 petitioner gave notice to the British Pacific Trust, Ltd., of its election to exercise the "put" and sell the Pressed Steel common. It also authorized its officers to sell 81,667 Pressed Steel preferred to Schroder at Pound 1/0/9 or Pound 101,063. About February 15, 1936, the transactions were consummated at Schroder's London office. Petitioner transferred*1088 332,595 Pressed Steel common (then convertible into 5s shares) "to Schroder and British Pacific Trust, Limited" and 81,667 Pressed Steel preferred to Schroder. British Pacific paid to Schroder and Schroder credited petitioner's account with Pound 1,122,508/2/6 ($5,601,315.54) for the Pressed Steel common. Schroder also credited petitioner's account with Pound 101,062/18/3 ($503,303.93) for the Pressed Steel preferred. The total credit was Pound 1,233,571/0/9 ($6,105,619.47), and a charge for expenses left a credit equivalent to $5,830,990.34 as net proceeds from the sale. Schroder and the Schroder Banking Corporation, New York, sent to petitioner certificates for 51,429 and 17,143 shares of its preferred, respectively, and the total number, 68,572 shares, were canceled. Petitioner redeemed them at the rate of $57 a share. Redemption payment was *744 made by a charge of $3,908,604 against petitioner's account with Schroder. A credit of $1,922,386.34 remained in the account.
On February 17, 1936, petitioner's board of directors directed that there be set up a reserve of $1,032,000 "for unpaid expenses, etc., in connection with the sale of the interest in the British*1089 company," and, after noting that $1,670,000 still remained in the treasury, they declared a dividend of $12.25 a share on the outstanding 8,000 preferred shares and $1.50 a share on the outstanding 436,572 common shares. These distributions of $98,000 and $654,858, respectively, were made on February 20. On March 5, 1936, pursuant to a directors' resolution of the same date, petitioner made a further distribution of $44,75 a share in redemption of the 8,000 preferred shares which it thus acquired and canceled. The $3.50 annual cumulative dividends on 76,572 preferred shares were in arrears from June 30, 1932, and amounted on December 31, 1935, to $12.25 a share, or $938,007.
After the above transactions and distributions, petitioner's remaining assets consisted of the Ambi-Budd shares and license contracts with European manufacturers. A profitable disposition of these assets was hindered by financial restrictions and other conditions in Europe and the necessity for the Manufacturing Co.'s collaboration with its licensees. Royalties from European licenses and expenses connected therewith were as follows:
| 1936 | 1937 | 1938 | 1939 | |
| Royalties | $241,491.69 | $377,155.33 | $392,412.26 | $357,792.11 |
| Expenses | 306,563.30 | 279,760.09 | 220,337.17 | 240,057.90 |
*1090 In determining petitioner's income tax for 1936, the Commissioner adopted the petitioner's return of $4,486,532.33 gain on the sale of Pressed Steel shares, which was computed by taking the selling price of $5,830,990.34 and the basis of the transferor Manufacturing Co.'s cost of $1,344,458.01. The selling price was computed as comprising $3,908,604, the figure at which petitioner's preferred shares were redeemed, and $1,922,386,34, the final credit in petitioner's account with Schroder. The Commissioner allowed a dividends paid credit of $654,858 for 1936.
On December 31, 1935, petitioner on its books entered $5,587.91 as accrued Federal capital stock tax for the year ending June 30, 1936, and deducted the amount on its 1935 income tax return. On September 29, 1936, it filed a capital stock tax return for the year ending June 30, 1936. The return declared the value of petitioner's capital stock on December 31, 1935, to be $55,000,000 and indicated a tax of $55,000, which was paid when the return was filed. In determining *745 petitioner's 1935 income tax the Commissioner deducted $55,000 on account of capital stock tax for the year ending June 30, 1936.
On July 31, 1937, petitioner*1091 filed its Federal capital stock tax return for the year ending June 30, 1937, showing a tax of $54,318, which was paid when the return was filed. On petitioner's books, Federal capital stock tax was debited with $55,000 under date of September 30, 1936, and with $54,318 under date of July 31, 1937. Petitioner also maintains an account "Deferred Federal Capital Stock Tax" which reflects portions of the capital stock taxes which it currently charges to operations of the next succeeding six-month period. At the end of both 1936 and 1937 a credit of $27,500 "to balance" was entered in the account and carried on the asset side of the balance sheet as a "deferred Charge."
On its 1936 income tax return, petitioner deducted $104,400 on account of Federal capital stock tax, consisting of $49,930 [sic] and $55,000 for the years ending June 30, 1936 and 1937, respectively. The Commissioner allowed the deduction of $55,000, the tax paid for the year ending June 30, 1937, and disallowed the $49,930.
On March 14, 1938, petitioner filed its 1937 income tax return, and deducted $54,318 as Federal capital stock tax, which was allowed. On August 1, 1938, petitioner filed its Federal*1092 capital stock tax return for the year ending June 30, 1938, showing a new declared value of capital stock of $15,000,000 and a tax of $15,000, which was paid when the return was filed.
In 1937 petitioner held common shares of Ambi-Budd of a par value of RM 3,626,962. Ambi-Budd required working capital, and Schroder agreed to lend it RM 1,500,000 if it would reduce the Pound 303,600 unpaid principal of a loan owed to a London syndicate. The loan was partly secured by shares of Alder Co. which could be sold for a price payable only in blocked marks. To induce the syndicate participants to approve this sale, Ambi-Budd offered to each either blocked marks or common shares of Ambi-Budd. Holders of 50.2 percent participation in the syndicate chose the shares, which were obtained pro rata from Ambi-Budd's shareholders. Petitioner surrendered common shares of a par value of RM 91,027, which had cost it $86,704.54. On its 1937 income tax return it deducted the cost as an ordinary loss and the Commissioner limited the deduction to $2,000.
OPINION.
STERNHAGEN: 1. The first matter to be determined is the petitioner's basis of gain on the sale of its Pressed Steel common in*1093 1936. Petitioner demands the use of its own cost and respondent demands the use of the preceding owner's cost. This dispute turns upon the legal question whether the exchange in 1930 by Schroder and *746 the Manufacturing Co. of cash and assets, respectively, for petitioner's shares was tax-free under the Revenue Act of 1928, section 112(b)(5). 1 If the proportions in which petitioner's shares were issued to them were the same as their proportionate ownership had been of the assets and cash which they transferred to petitioner, the exchange was tax-free, and the basis to be used by petitioner in computing gain is the same as the basis applicable to the transferor Manufacturing Co. This, it is agreed by both parties, was the $1,000,000 cost which had been paid by the Manufacturing Co. in 1926. In using this basis the Commissioner made no affirmative determination, but only adopted that figure as used by petitioner on its 1936 return upon the conception that the 1930 exchange was tax-free under section 112(b)(2).
*1094 In lieu of the transferor's basis of $1,000,000, petitioner now demands the use of its own actual cost in 1930, and this it seeks by evidence to establish at $3,500,000. It argues that the shares issued by it in 1930 to the Manufacturing Co. and Schroder were not proportionate to the assets and cash which they respectively transferred to it, and that it is now incorrect to carry forward the Manufacturing Co.'s cost as its basis, as if section 112(b)(5) were applicable. If that proposition be established, petitioner's next step is to prove that the actual cost to it in 1930 of the Pressed Steel common which it sold in 1936 was more than $1,000,000.
Since we are of opinion that the petitioner's cost of Pressed Steel common in 1930 has not been established at a greater figure than $1,000,000, we may adopt arguendo the view that the 1930 transaction was not tax-free under section 112(b)(5). This view is only taken hypothetically, since a decision on the point is unnecessary and would be obiter; but we are inclined to the view that the Manufacturing Co.'s assets and Schroder's cash were not in the same retio as the petitioner's shares which they respectively received. Both*1095 section 112(b)(5) of the 1928 Act and section 113(a)(8) of the 1936 Act are exceptions to the general clause of each of those sections. Unless the special facts appear which are described in those sections, the special clause has no application and the general rule applies. The general rule of section 112(a) of the 1928 Act provides that *747 the entire amount of gain shall be recognized, and the general rule of section 113(a) of the 1936 Act provides that the basis shall be cost. Therefore, in the 1930 transaction the gain was required to be recognized, and in the 1936 sale the actual cost to the petitioner was required to be used, unless it was affirmatively established that the Manufacturing Co. and Schroder each received the petitioner's shares in the same ratio as their ownership in the assets and cash they transferred. There has never been an official determination that those ratios were substantially the same, and such a finding may not be made merely because that postulate was apparently used by the Manufacturing Co. on its 1930 return, which was adopted by the Commissioner, and was again used by the petitioner as the basis for gain on its 1936 return and adopted*1096 by the Commissioner. There is nothing to indicate that at any time the actual or relative values of the assets transferred by the Manufacturing Co. to petitioner in 1930 were investigated or determined. The evidence in this proceeding gives little ground for a determination of the value of all the Manufacturing Co. assets or of the ratio of such value to the $3,000,025 cash paid by Schroder. If a finding of fact were unavoidable, the evidence would tend to establish that the ratio of assets and cash transferred was not the same as the ratio of shares issued to each. Thus the Manufacturing Co. would have had a recognizable gain based upon its actual cost of the Pressed Steel shares, and petitioner would not be required to use that cost as its own basis. Petitioner's basis would be its own actual cost of the Pressed Steel shares, and this cost would be the value of such of petitioner's common shares issued to Manufacturing Co. as could be identified or allocated as the price of the Pressed Steel shares.
It can not, however, be found as a fact upon the evidence that petitioner's direct cost of the Pressed Steel common was more than $1,000,000, the figure which it used on its return. *1097 It paid 360,000 common shares for the composite group of assets and promises given by the Manufacturing Co. The $344,458.01 cash and the guaranty may properly be put aside as being clearly regarded as cost of the 1,000 shares of Pressed Steel preferred. It is impossible to assign any definite portion of petitioner's common as the cost of the Pressed Steel common. Petitioner has submitted no evidence upon which such an allocation can be based. Its proof has been directed to the value of the Pressed Steel common at the time of the exchange, and has consisted largely of the opinions of persons who were at that time in one way or another connected with the business or with the financial aspects of the exchange transactions. These opinions, however, related to the value not of the petitioner's shares given up, *748 but of the Pressed Steel shares received. This obviously does not determine its cost, for a purchaser's cost is not as a rule determined by the value of the property purchased. The value of all assets transferred to a newly formed corporation has sometimes been accepted as evidence of the value of all its shares; *1098 ; affd., ; ; affd., ; but the value of one of several assets transferred for less than the aggregate of the shares issued gives no help in the effort to determine the specific value of the shares issued for the particular asset. .
Since, therefore, the petitioner's cost was 360,000 common for the entire conglomeration of Manufacturing Co. assets and promises (except the Pressed Steel preferred), it is not possible to say what portion thereof is assignable as the cost of the Pressed Steel common; and this is true even though the value of the Pressed Steel common was $3,500,000, as opined by witnesses, or $2,000,000, as entered on the books. There is no ground upon which to distribute the petitioner's common among the several assets and promises received therefor; there is no proof upon which the number of shares issued as cost of the Ambi-Budd shares can be found either relatively or absolutely, and this is likewise true as to the absolute or relative number of*1099 shares to be regarded as the cost of the licenses, contracts, and promises. All of these seem to have been regarded as substantially valuable. For the purpose, therefore, of determining the cost of any part of what was received from the Manufacturing Co., it is of little or no assistance to know the several figures which witnesses regard as the value of the Pressed Steel common so received.
The issuance to Schroder of 68,572 preferred and 68,572 common for its cash of $3,000,025, while at the same time 8,000 preferred and 8,000 common were issued to the Manufacturing Co. apparently for its cash of $350,000, presents another obstacle to the proper evaluation of any portion of petitioner's common to be used as cost of the Pressed Steel common. In petitioner's brief, it is said that the 68,572 shares of common were issued to Schroder as a bonus with the 68,572 preferred. The preferred was said to have a value at that time of $43.75, which is the figure which results from dividing $3,000,025 by 68,572 preferred and dividing $350,000 by 8,000 preferred. If this value of the preferred were to be taken as the fact, it would leave the 68,572 common which were issued to Schroder and*1100 the 8,000 issued to the Manufacturing Co. as having no unit value. How then can it consistently be said that the 360,000 common are to be given the substantial value claimed for them? There is nothing in the evidence from which these two propositions can be reconciled *749 and nothing from which a unit value can be attributed to all the common shares. That the common had substantial value is clear enough in view of its voting rights. It is impossible, however, to go further than that upon this record and determine what that value was.
It can not be found that the Pressed Steel common acquired by the petitioner from the Manufacturing Co. in 1930 had a cost in excess of the $1,000,000 which petitioner used on its return and respondent adopted without change. This figure must remain unchanged as the basis of gain to petitioner in the sale of 1936.
2. The petitioner claims that the gain from the sale of Pressed Steel shares was incorrectly computed because the disposition of such shares was partly in a "swap" for Schroder's 68,572 International preferred shares received by it for redemption. There is not sufficient evidence to show that the transaction was in form or*1101 substance an exchange. The evidence shows that, irrespective of what may have been tentatively wished or expected, the disposition of the Pressed Steel shares was by sale to British Pacific and Schroder for separate definite money prices; and that petitioner also redeemed Schroder's 68,572 shares of International preferred at $57 a share, and retired them. These were two transactions and their close proximity in time does not unify them in a single exchange. The 332,595 Pressed Steel common were sold to the British Pacific Trust, after petitioner had paid it Pound 16,629/15/0 for a "put", and were sold in accordance with its terms. British Pacific had no shares of petitioner and was therefore not making an exchange. The price paid, Pound 1,122,508/2/6, was exactly the amount which British Pacific had agreed to pay, and this was credited to petitioner's account by Schroder as petitioner's banker in London. Although the stipulation states that the shares of Pressed Steel common were transferred to both the British Pacific Trust and Schroder, this is not explained and is inconsistent with the "put" and its exercise. So far, therefore, as the Pressed Steel common are concerned, *1102 there is no room for doubt that they were sold by petitioner for $5,601,315.54, the exchange equivalent of Pound 1,122,508/2/6.
The disposition of the 81,667 shares of Pressed Steel preferred must also be regarded as a sale to Schroder for $504,303.93, the exchange equivalent of Pound 101,062/18/3, which was credited by Schroder, in its capacity of petitioner's banker, to petitioner's account. This was the form of the transaction accepted by all concerned, and its character is not changed by the insistence of Schroeder that its holdings of International preferred shares should be redeemed. Petitioner was concerned with securing funds with which to curtail the outstanding loan by the Federal Reserve Bank to the Manufacturing Co. Its primary interest at that time was not the redemption of *750 its outstanding preferred. It was because of Schroder's demand that petitioner agreed to the acquisition of its 68,572 preferred, and it was adventitious that, since Schroder was both petitioner's banker and the holder of International preferred, the two transactions were accounted for on Schroder's books. All of the writings which passed between the parties to the transaction, which*1103 are in evidence, speak of the transaction as a sale by petitioner of its Pressed Steel shares for a stated price. Nowhere does it appear that the disposition of the Pressed Steel shares was to be accomplished by an exchange; and such a character can not be attributed to all or any part of the transaction consistently with what the parties said they were doing and what they actually did. The first letter on the subject, which is in evidence as Stipulation Exhibit 14, written on December 11, 1935, by Schroder to a representative of the Bank of England, describes the proposed transaction as follows:
Budd International Corporation have now received a cash bid for the whole of its holding of the Pressed Steel Company Ordinary Shares of Pound 1 each of a price of Pound 3. 7. 6 per Share, involving a total payment of about Pound 1,122,500. The purchaser is the British Pacific Trust Ltd. of Cleveland Row, S.W. 1.
It is the intention of the Budd International Corporation to redeem out of the proceeds of the sale of the Pressed Steel Company's Ordinary Shares the whole of its own Preference Shares at the price of $57 per Share, with the result that Pound 780,000 will be payable to us*1104 in redemption of our holding of these Preference Shares.
The transaction will be carried out as follows:
The total purchase price for the Pressed Steel Ordinary Shares will be paid to us in Pound stg. by the buyers and the Budd International Corporation will authorize us to retain for our own account Pound 788,000 being the equivalent of $57 per Share for the redemption of the Budd International Corporation Preference Shares held by us. The balance of the purchase price, i.e. about Pound 342,500 will be transferred to the Budd International Corporation in the United States in Dollars.
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* * * Incidentally we ourselves are purchasing for our own account from the Budd International Corporation their holding of 81,667 Pressed Steel Company Limited 6% Preference Shares at the price of Pound 1. 4. 9 per share net * * *.
On January 3, 1936, petitioner's directors passed a resolution to exercise the "put" and require British Pacific to buy petitioner's 332,595 Pressed Steel common at Pound 3. 7. 6.
On February 14, 1936, petitioner's solicitors in London wrote to petitioner that the sale of the Pressed Steel common to British Pacific was completed and that British Pacific*1105 had paid to Schroder in London Pound 1,122,508/2s/6p; that to Schroeder had been delivered 81,667 Pressed Steel preferred for a credit of Pound 101,062/18s/3p.
We understand that Messrs. J. Henry Schroder & Co. are carrying out your instructions with regard to the purchase of your Corporation's own Preference Shares at $57 per share * * *.
In *751 view of this consistently clear treatment of the transaction as a sale by petitioner of the 332,595 shares of Pressed Steel common to British Pacific at a stated price and the 81,667 shares of Pressed Steel preferred to Schroder at a stated price, and the separate redemption of Schroder's International preferred for a fixed price of $57 per share, which petitioner was paying out of the proceeds of the sale of the Pressed Steel shares, it would be a wholly unjustified and forced construction to characterize these several transactions as a single unified exchange of Pressed Steel common and preferred for International preferred and cash. In fact, there was no such exchange; and we see no reason now, for the sake of a tax effect, to say that petitioner should be treated as if it had made such an exchange.
It would be an impollible*1106 Procrustean task to attempt to shape the various steps to fit the conception of an exchange. Certainly British Pacific was no party to an exchange, and yet petitioner would say that the Pressed Steel common shares were to some extent exchanged for International preferred. International preferred was redeemed by petitioner at $57 a share, and this could only have been paid, as it was, to a large extent with the cash derived from British Pacific. At the fixed price at which Pressed Steel preferred was sold to Schroder, the proceeds were wholly inadequate to provide an amount sufficient to redeem the International preferred at the fixed redemption price. Furthermore, within a short time after these transactions were completed, petitioner redeemed the remaining 8,000 shares International preferred held by the Manufacturing Co. and the redemption price was at the same $57 rate as that paid to Schroder. Against this harmonious group of facts it would be wholly unwarranted to find that a swap had taken place, largely because there is testimony that petitioner's representative at the outset of the negotiations thought that a swap might be worked out and the transactions consummated in*1107 that manner.
It may be added, however, that, even if the Schroder part of the transaction could be regarded as a swap, there would still be too little support for relieving the petitioner of a tax on the resulting gain. Regulations 94, art. 22 (a)-16, in effect in 1936, were different from that considered by the Court in , and provided that the recognition of gain depended upon "the real nature of the transaction." See ; . The redemption of International preferred was not so dominant as to characterize the supposed exchange as not primarily the sale of petitioner's Pressed Steel preferred, but the redemption of its own preferred. The evidence shows, rather, that, for the purpose of getting funds with which to curtail the Manufacturing *752 Co.'s indebtedness to the Federal Reserve Bank, petitioner was selling an asset. This was the dominant fact which more properly determines the "real nature of the transaction", and while we confess to some difficulty with the term "real nature of the transaction", *1108 we can not conclude that upon the evidence it is controlled by the redemption of the International preferred.
The dispositions of the Pressed Steel common and preferred were correctly treated as sales; the sale price was $5,830,990.34 (after subtracting the expense charge which is not in dispute); the basis was $1,344,458.01, and the correct gain was $4,486,532.33, as adopted in the determination of the deficiency.
3. The amount of deduction for Pennsylvania franchise tax is stipulated and the amount of the deduction for Pennsylvania income tax will, the parties agree, be computed in accordance with the Federal tax resulting from the disposition of the issues in this proceeding. Both deductions will, it is agreed, be given effect in the computation under Rule 50.
4. The petitioner claims a deduction for 1936 of the $49,400 Federal capital stock tax for the fiscal year 1935-1936 which it deducted for its income tax calendar year 1936 and which the Commissioner disallowed on the ground that it was properly deductible for the income tax year 1935. In 1935, acting upon the capital stock tax statute of August 30, 1935, petitioner on its books accrued $5,587.91 as the capital*1109 stock tax of 1935-1936. This was upon the basis of a continuation of the declared value of $4,000,000 which had been used in 1934-1935 under the 1934 Act, section 701, to which was applied the increased rate of $1.40 per $1,000 which had been imposed by the 1935 Act, section 105. The books were generally on an accrual basis. The Revenue Act of 1936, section 401, changed the rate back to $1 per $1,000 in June 1936, and petitioner, having in mind the proceeds from the sale of the Pressed Steel shares and the excess profits tax thereon, concluded to avail itself of the right to declare a new value of capital stock. It declared the value at $55,000,000, with the resulting tax of $55,000 instead of the $5,600 which it had accrued. This additional $49,400 it accrued on its books for its income tax year 1936, and deducted the amount on its 1936 income tax return. Later in 1936 it computed its capital stock tax for 1936-1937 upon the same basis of declared value of $55,000,000, accrued this capital stock tax on its books in the calendar year 1936, and deducted the tax on its 1936 income tax return. It insists upon the right to the deduction in 1936 of both amounts. The Commissioner*1110 has disallowed the $49,400 applicable to the year 1935-1936.
Upon the taxpayer's method of accounting, it must be held that the entire capital stock tax for 1935-1936, payable upon the value which it declared, was the tax which accrued in the calendar year *753 1935. While the amount was not stated in 1935, and indeed may not have been known as long as the declared value was not decided, the accrual of capital stock tax was an established practice, and this had been followed by the petitioner's accrual of the tax which at that time was believed by it to be the entire and correct tax. Having chosen and been allowed that method of accounting for its capital stock taxes, it had the right to use it in respect of the capital stock taxes for 1935-1936. But it could not split up the single annual tax of this year and deduct part for 1935 and the rest for 1936. Its method of accounting must be consistently used and an error or accident may not be permitted to be the means of accomplishing an obvious distortion. No point is made of the petitioner's change of valuation; and although it might have had some right, upon application, to change its accounting method if it had applied*1111 the change to the entire new tax, this question is not here. Petitioner had no right, while adhering to its accounting method and accruing one part of the year's tax, to accrue the remaining part in the following year and spread the deduction. This is made stronger by the petitioner's adherence to the adopted accounting method in the latter part of 1936, when it accrued the entire capital stock tax for 1936-1937, and deducted it on its 1936 income tax return.
5. A question is raised affirmatively by the respondent relating to the deduction taken by the petitioner on its 1937 income tax return for capital stock tax of 1937-1938. The Revenue Act of 1936 was in force in 1937 and carried the $1 capital stock tax which has been considered in the preceding point. Before the end of 1937, petitioner accrued on its books the $54,318 capital stock tax based upon its adjusted declared value of $54,318,128.80 as used in the 1936 return and deducted it on its 1937 income tax return. This was not changed by the Commissioner in determining the deficiency. By the act passed in May 1938, the provisions of the capital stock tax were changed and the petitioner availed itself of the opportunity*1112 to declare a new capital stock value. It substituted a declared value of $15,000,000 and this resulted in a capital stock tax of $15,000 instead of the $54,000 which had been accrued and deducted. The Commissioner now demands a correction of the deduction and a disallowance of the excessive $39,000.
There is no escape from the Commissioner's position. A taxpayer may not deduct more than the correct amount of the tax, irrespective of the accounting method. He may not support a deduction by making an incorrect accrual of an excessive amount, even though he is unaware of the correct amount. Such an excessive accrual is only provisional. The question which might emerge from such a mistake as to the proper treatment of a subsequent refund of an excessive *754 amount paid, has given rise to much discussion, see . But there is no doubt that a correction of the original deduction when timely made while the determination of the correct tax for the original year is still in litigation, may properly be demanded and is not to be denied. The Commissioner's affirmative claim is sustained.
6. In computing the undistributed profits*1113 tax of section 14, the Commissioner allowed a credit of $654,858 for dividends paid. This was the amount of the dividend of $1.50 per share paid February 20, 1936, on the outstanding 436,572 common shares. The petitioner, however, demands additional credits, both for dividends paid on the preferred shares and for an amount alleged to be the subject of an express contractual prohibition covered by section 26.
There is no need to repeat what has been said in holding that the disposition of the Pressed Steel shares was not an exchange for International preferred. The entire proceeds of $5,830,990.34 were within the petitioner's earnings and profits for 1936 and not only the $1,922,386.34 which remained at petitioner's disposal after the International preferred purchase price to Schroder had been applied against it. The prior demand of Schroder that its International preferred should be redeemed did not have the effect of taking this amount out of petitioner's earnings and profits. It must be regarded as first coming to petitioner as income and then going from petitioner to Schroder in payment of the redemption price on International preferred. The fact that petitioner had been*1114 committed to the redemption and that Schroder used the British Pacific proceeds as payment in redemption does not make the funds so used anything other than the income they would have been if transmitted by Schroder as banker to petitioner and by it in turn sent back to Schroder as shareholder in redemption of the shares.
That under proper circumstances an amount paid to shareholders in liquidation of their shares may be regarded as the proper subject of the dividends paid credit is established by . But this can not serve the petitioner in this proceeding, because it is net by the preclusion of the statute, section 27(g), that the amount of a preferential dividend may not be the subject of a credit. When the petitioner made its payment to Schroder for the 68,572 preferred shares, it made no similar payment to Manufacturing Co. in respect of iyd 8,000 preferred shares and had no commitment by resolution or otherwise to make such a payment either as a dividend or in redemption. It was purchasing Schroder's 68,572 shares because Schroder required it to do so, and not because of any uniform plan to redeem*1115 all the shares of the same class outstanding. To the extent that the $57 a share paid to Schroder may have been a dividend under section 27*755 (f), it is not the proper subject of a credit because it was a preferential dividend under section 27(g), , affirming ; .
There is also a lack of foundation for the credit under the contract provision of the statute, section 27(c). That section provides for the credit if the taxpayer is prohibited from paying a dividend by the express terms of a contract relating to dividends. There is no such contract. The petitioner relies upon the correspondence between it and Schroder agreeing to the redemption; but construing the letters and cablegrams most favorably for petitioner, they contain nothing prohibiting the payment of a dividend. They simply agree to the purchase or redemption and fix the price at $57 a share to be paid by a debit against the British Pacific proceeds. They contain no reference to a dividend, either express or implied. *1116 Nor is there anything in the point that the terms of the preferred issue must be regarded as the terms of a contract. This contention was considered in (on review C.C.A., 3d Cir.), and it was held that the terms of shares are not contractual within the statutory meaning and do not support the credit. See also ; .
There is, however, ground for credit of the $98,000 dividend paid upon the 8,000 shares of preferred held by the Manufacturing Co. After petitioner had redeemed the 68,572 shares of preferred held by Schroder, the 8,000 of preferred held by Manufacturing Co. were the only shares of this class still outstanding. On February 17 and at the same time that it declared the $1.50 on the common, petitioner declared a dividend of the accumulated $12.25 a share on the outstanding preferred. This was a dividend of $98,000 which involved no prefernce among the holders of shares of that class. Not until March 5, 1936, were the 8,000 shares redeemed at $44.75 a share. No part of this was a*1117 dividend and the petitioner does not so contend. Its argument treats the $12.25 paid on each preferred share held by both Schroder and the Manufacturing Co. as the subject of a dividends paid credit. The reason against this is, as has been stated, that so much as was paid to Schroder was what the statute calls a preferential dividend, the credit for which is expressly prohibited. No such reason is, however, applicable to the dividend later paid on the remaining 8,000 shares held by Manufacturing Co., and therefore the credit for $98,000 may not be denied.
7. The Comissioner in the determination of deficiency held that petitioner, in surrendering Ambi-Budd shares having a cost basis of $86,704.54 for the purpose of enabling the corporation to transfer them to the syndicate participants for their acquiescence in the sale of *756 the Adler shares, is entitled to the deduction of only $2,000 thereof, because the surrender "constituted a sale of a capital asset." Thus the Commissioner has held that the petitioner sustained a loss (see *1118 ), and relies upon the limitation of its deduction under section 117(d), Revenue Act of 1936. This provides: "Losses from sales or exchanges of capital assets shall be allowed only to the extent of $2,000." It is applicable to corporations, . These shares clearly were "capital assets" as that term is defined in subdivision (b) of the section; and if they were sold or exchanged, the limitation applies. Much of the argument has been pointed at the question whether petitioner in fact sustained a loss, but that question has never been properly at issue, in view of the Commissioner's recognition that a loss was sustained, the deduction of which is limited to $2,000; so the fact of loss may be adopted, and the decision limited to the question of its deductibility.
The $2,000 limit upon gain is only applicable to the gain from sale or exchange, , and, since the statute speaks of "gain or loss", it is likewise true that the deduction of loss is limited to the loss resulting from sale or exchange. In *1119 , it was held that the gain received by a bondholder in the redemption of his bond was not derived from a sale or exchange and was therefore not subject to the capital gain tax, but to ordinary tax. See also ; . There is nothing in the circumstances of the disposition of petitioner's shares to give color to the idea that there was a sale or exchange. Petitioner received nothing, unless it be the possible effect upon its remaining shares. What the effect was does not appear; but there was nothing more tangible. It merely gave up its shares to the issuing corporation and received nothing. Since a taxpayer bondholder receiving money on redemption is held not to have disposed of his bond by sale or exchange, it is impossible consistently to say that a shareholder who surrenders his shares for no money, property, or rights is making a sale or exchange.
The undisputed loss is deductible to its full amount, and the Commissioner's limitation of the deduction is reversed.
Other matters suggested in the petition*1120 have not been covered in the trial or the briefs, and are therefore regarded as abandoned.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 112. RECOGNITION OF GAIN OR LOSS.
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(b) EXCHANGES SOLELY IN KIND. -
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(5) TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR. - No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange. ↩