*1025 STOCK DIVIDEND. - A taxable stock dividend resulted where preferred stock was issued proportionately to the holders of no par value common stock and the only change in the no par value common stock, the only other outstanding stock, was to reduce its "stated value" by an amount equal to the par value of the preferred stock.
*1117 The Commissioner determined a deficiency of $150,596.51 in the petitioner's income tax for the calendar year 1937. The petitioner assigns as error the action of the Commissioner in holding that 2,725 1/2 shares of preferred stock of Bird & Son, Inc., received by the petitioner in 1937, constituted a taxable dividend.
FINDINGS OF FACT.
The petitioner filed her individual income tax return for 1937 with the collector of internal revenue for the district of New Hampshire.
Bird & Son, Inc., was incorporated in 1918 under the laws of Massachusetts. It has engaged successfully and increasingly in the business of manufacturing and selling paper and paper products. Its authorized and*1026 outstanding capital stock on September 14, 1937, consisted of 600,000 shares of common stock without par value. All of those shares were held by a voting trust which was to terminate on October 9, 1937. Voting trust certificates for most of the stock were held by officers and employees of the corporation and members of the Bird family. There was no market for the voting trust certificates and many holders thereof had indicated that they were in need of some cash and had requested that some arrangement be made to afford a satisfactory market in case they desired to sell a portion of their holdings. A committee was appointed in May 1937 to consider the question. The committee proposed a plan which was ultimately approved and carried out.
The recommendations of the committee were prompted, first, by a desire to provide marketable shares and thus satisfy the shareholders, and, second, to provide the corporation with some additional marketable shares which it could sell and thus eliminate large borrowings which were being used in the business or which could be used to capitalize profits, if that should prove desirable. The committee members gave some consideration to the tax consequences*1027 of the plan and received advice of counsel on that subject. They felt that the approaching *1118 termination of the voting trust provided a suitable time for the change. They believed that $6,000,000 was a sufficient and proper capitalization for the corporation and surplus should not be changed but should be left as it was for future corporate purposes.
The plan was to increase "the authorized shares of capital stock from 600,000 shares without par value of common stock to 50,000 shares par value $5,000,000 of preferred stock and 600,000 shares without pay value of common stock, 30,000 shares of preferred stock to be issued in exchange for 300,000 shares without par value of common stock, having a stated value on the books of the corporation of $3,000,000, and the number of shares without par value of common stock to then be increased to 600,000, so that the entire exchange would be effected without change in capital, the 30,000 shares of preferred stock to be issued being represented by $3,000,000 of capital and the 600,000 without par value of common stock being represented by $3,000,000 of capital (instead of $6,000,000 as heretofore)." The remaining 20,000 shares of*1028 preferred were to be retained for whatever future use the directors might deem proper. The preferred and common stock was to be listed on a stock exchange. No change was to be made in the existing surplus and undivided profits.
The board of directors proceeded to carry out the plan immediately after receiving the approval of the state authorities on September 14, 1937. The certificate for 600,000 shares of the outstanding common held by the voting trustees was surrendered and canceled. Temporary certificates for 30,000 shares of preferred and for 300,000 shares of common were issued in the name of the voting trustees. The temporary certificate just mentioned for 300,000 shares of common was canceled and a temporary certificate for 600,000 shares of common was issued in the name of the voting trustees. The certificates, above mentioned, were all dated September 15, 1937, and the various acts just described relating to those certificates were all performed on one day. Appropriate entries were made on the books of the corporation. The capital stock account on September 14, 1937, showed a stated capital of $6,000,000 represented by 600,000 shares of no par common stock. That*1029 capital stock account, at the conclusion of the above described transaction, showed $3,000,000 represented by 600,000 shares of no par common stock and $3,000,000 represented by 30,000 shares of preferred. No entries were made in the surplus account as a result of the transactions. The earned surplus, as shown on the books, remained at $5,701,003.82 throughout the transactions. The stated capital of $6,000,000 included a prior capitalization of earnings in the amount of $4,000,000.
The 600,000 shares of common stock prior to September 15, 1937, represented the entire capitalization of the corporation in the amount *1119 of $6,000,000, whereas, after the above transactions, the 600,000 shares of common represented on the books only $3,000,000 of the total capitalization of $6,000,000, but otherwise the common stock was the same in every respect after the transactions as it had been before.
The holders of voting trust certificates were requested to send in the certificates so that they could receive certificates for common and preferred stock to which they would be entitled upon termination of the voting trust on October 9, 1937. The petitioner was the owner on September 14, 1937, of*1030 a voting trust certificate representing 54,510 shares of common stock. She surrendered that certificate and received in 1937 a certificate for 54,510 shares of common stock and a certificate for 2,725 1/2 shares of preferred stock. The fair market value of the preferred stock at the time she received it was $86 per share.
The common stock was listed on the Boston Stock Exchange in October 1937. The preferred stock was not listed because listing of the common stock qualified the preferred for sale under the laws of Massachusetts and afforded a satisfactory over-the-counter market for the preferred stock. The corporation has never issued any of the additional 20,000 shares of preferred stock. It made arrangements in the fall of 1937 whereby another corporation financed the sale of its products. This permitted the elimination of the bank loans without use of the preferred stock.
The stipulated facts are incorporated herein by this reference.
OPINION.
MURDOCK: The petitioner argues that there was a recapitalization which, under the definition in section 112(g)(1)(D) of the Revenue Act of 1936, amounted to a reorganization and there was an exchange of stock for stock within*1031 section 112(b)(3), so that no gain or loss from the transaction can be recognized. The Commissioner is not contending that taxable gain resulted from the transaction. He has determined that the issuance of the preferred stock to the holders of the common stock was a taxable dividend, and the issue is whether or not that determination is correct. The petitioner's argument is somewhat beside the point, as are cases such as , and , involving exchanges. She has not said in her briefs just what exchange she thinks took place, but she must reason either that one-half of the original common stock was exchanged for the preferred stock or that all of the original common stock was exchanged for the preferred and a different common stock, with the result, in either case, that the preferred could not have been received as a dividend on any of the original common stock, since that stock disappeared in the exchange. The Commissioner replies that the original common *1120 stock was not exchanged for new common stock and the preferred stock; instead, there was no real*1032 change in the common stock; the net result of the transaction was merely the issuance of the preferred stock; and the same result could have been reached directly by simply issuing the preferred stock. The petitioner argues that there was a substantial change in the common stock which made the last 600,000 shares quite different from the original 600,000 shares since each share "represented only half the interest it had formerly represented." She concedes that the stock was the same in all respects save one, that in the beginning the stated value of the 600,000 shares was $6,000,000, whereas, afterwards, the stated value of the then outstanding 600,000 shares was $3,000,000. The question of whether or not for income tax purposes there was any substantial change in the common stock as a result of this transaction thus arises.
The stockholders themselves did nothing. The voting trustees originally held a single certificate for 600,000 shares of common stock having no par value. The following events then took place on the same day: The voting trustees surrendered the certificate for 600,000 shares of common, a certificate for 300,000 shares of no par common, and a certificate for*1033 30,000 shares of preferred were then made; the certificate for 300,000 shares of no par common was immediately canceled and a certificate for 600,000 shares of no par common was issued; changes were made on the books so that the aggregate stated value of $6,000,000, at which the original 600,000 shares of common were carried, was reduced to $3,000,000, and a stated value of $3,000,000 was put on the books for the 30,000 shares preferred. The voting trustees came to the transaction with a single certificate for 600,000 shares of no par common and went away with a certificate for 600,000 shares of no par common and a certificate for 30,000 shares of preferred.
If it proper to look through these steps to see what business purpose was accomplished and also to see what was accomplished for Federal income tax purposes. Cf. ; art. 112(a)(1), Regulations 94. The record fails to disclose any business purpose or substance in the surrender of the original certificate for 600,000 shares of no par common, the issuance of a certificate for 300,000 shares of that stock, the cancellation of that certificate and the issuance of another certificate*1034 for 600,000 shares of the same kind of stock. The same result could have been reached, so far as this record shows, by merely issuing a certificate for 30,000 shares of preferred stock, allowing the voting trustees to retain the original certificate for 600,000 shares of no par common, and making book entries showing that 30,000 shares of preferred represented $3,000,000 of capital and the 600,000 common shares without par value had henceforth a stated value of $3,000,000. The stated value of the common stock could have been reduced without changing the certificate. All semblance *1121 of an exchange disappears if the steps taken in regard to the certificates for the common stock are disregarded.
The stockholders in this transaction in reality surrendered nothing but merely received the new preferred stock. The common stock represented the entire ownership of the corporation prior to this transaction. After the transaction the preferred stock represented ownership to the extent of $3,000,000 only and the entire remaining ownership continued to be represented by the common stock. That is the usual result of a stock dividend. The result is not changed by reason of the*1035 devious route taken to accomplish it. Furthermore, the fact that there was a change in the stated value of the common stock on the books of the corporation does not change and is not inconsistent with the conclusion that there was a stock dividend issued.
The Supreme Court held in , that "where a stock dividend gives the stockholder an interest different from that which his former stockholdings represented he receives income." The same Court held later, in , and in , that a stock dividend paid in preferred stock to holders of common stock was income under the Constitution, even though it was exempt from tax under existing revenue acts. See also . The Court in those cases cited its earlier opinions in , and , in which the Court had said that the test of taxability of a corporate distribution lies in its effect upon the individual stockholder*1036 rather than upon the corporation or the stockholders as a group, and it does not matter that the value of the stock on which the distribution was made was thereby decreased. The normal result of declaring a dividend of any kind is to reduce the value of stock theretofore outstanding. The issuance of the preferred stock in the present case gave to the recipients an interest different from that represented by their former stockholders. That was the intent and purpose of the change. The corporation had more than sufficient earnings accumulated after February 28, 1913, to pay a dividend equal to the value of this preferred stock. The petitioner concedes that the issuance of stock involving the capitalization of earnings could result in a taxable dividend, but contends that this was a "split-up" involving merely a change in the character and number of shares by which existing capital continued to be represented and was not a taxable dividend. It is immaterial that the corporation did not capitalize any earnings to support the issuance of the preferred stock, since section 115(b) provides that "every distribution is made out of earnings of profits to the extent thereof." The Commissioner*1037 did not err in taxing the distribution of the preferred as a dividend. The value of the stock has been stipulated.
Decision will be entered for the respondent.