*1194 The decedent as a stockholder of the Sandusky Cement Co. in 1926 received a distribution from that company of bonds of a railway company, which the Cement Co. had acquired by purchase in 1922. Held, that the bonds received constituted a taxable dividend to the decedent to the amount of their fair market value at the date of receipt.
*28 This proceeding was brought to redetermine a deficiency in income tax of the decedent for the year 1926 of $1,624.48.
The petitioner alleges that the respondent erred in including in decedent's taxable income the value of certain bonds of the Toledo, Angola & Western Railway Co. distributed to her on January 1, 1926, by the Sandusky Cement Co. The petitioner asserts that such distribution was made in pursuance of a plan of reorganization as contemplated by section 203(c) of the Revenue Act of 1926 and hence was not taxable.
FINDINGS OF FACT.
The Sandusky Cement Co., hereinafter called the Cement Co., an Ohio corporation, was established about 35 years*1195 ago by A. St. John Newberry an his brothers. In 1921 there was discovered at Silica (near Toledo), Ohio, a rather extensive and valuable deposit of limestone. The Cement Co. acquired the limestone acreage and in 1922 determined to build at Silica a plant for the manufacture of portland cement. The only transportation facilities available were those of the Toledo, Angola & Western Railway Co., hereinafter called the Railway Co., which operated a railroad 10 1/2 *29 miles in length passing near the property of the Cement Co. At that time the Railway Co. was insolvent and its track and rolling stock were so badly out of repair and inadequate that it could not furnish proper transportation.
Early in 1922 the Cement Co., through its president, S. B. Newberry, and its counsel, A. C. Dustin, also a director and large stockholder, began negotiations for the purchase of the stocks and bonds of the Railway Co. by the Cement Co. On March 28, 1922, the owners of the Railway Co.'s securities granted an option to the Cement Co. to purchase the entire capital stock of the Railway Co., consisting of 3,000 shares of the par value of $100 each, and the outstanding issue of bonds, consisting*1196 of 300 bonds of $1,000 each, for $175,000, of which sum $25,000 was to be paid in cash and the remainder in five notes of the Cement Co. for $30,000 each. On March 1, 1922, the action of Newberry and Dustin in securing the option was approved by the board of directors of the Cement Co. On May 22, 1922, the board authorized and directed the officers of the Cement Co. to exercise the option and also authorized a loan of not to exceed $25,000 to the Railway Co. for the purpose of placing the property of that company in proper operating condition. On May 23, 1922, the Cement Co. entered into a written contract of purchase of the securities. The stock was transferred to certain individuals for the benefit of the Cement Co. The bonds contained interest coupons unpaid since 1918.
Between June 1, 1922, and November 1925, the Cement Co. advanced approximately $98,000 for the repair, rehabilitation and improvement of the Railway Co.'s property. Such advances were carried in an open account on the Cement Co.'s books and were duly authorized by its board of directors. The Cement Co. also guaranteed certain of the Railway Co.'s obligations.
The Railway Co. interchanged business with*1197 14 trunk-line railroads at Toledo. Its only source of revenue was allowances made to it by such railroads out of the Toledo freight rate. Prior to the acquisition of the Railway Co. by the Cement Co. the freight allowance on cement was 16 cents per ton. That rate was insufficient to cover operating expenses. The Cement Co. began the construction of its plant at Silica about June 1922, anticipating its completion in the spring of 1923. In October 1922, officers of the Railway Co. began negotiations with the trunk lines for increased freight allowances, particularly on cement. The trunk-line officials hesitated to increase allowances for fear of being charged with the granting of preferential consideration or rebates to the Cement Co. The officials of the latter company, however, gave their assurances that the Railway Co. was being held by the Cement Co. only until the Railway *30 Co. could be made self-supporting, whereupon its stocks and bonds would be divided and distributed among the Cement Co.'s stockholders.
After protracted discussions and negotiations the increased allowances were finally established in December 1923. The allowance on cement was fixed at 40*1198 cents per ton. The publication of tariffs and the preparation and distribution of division sheets were not completed until February 1924. Due to the long delay in reaching an agreement the new allowance on cement was made retroactive to May 31, 1923, and on other commodities to January 1, 1924. Before making payment of the additional amounts accruing under the retroactive clause the trunk lines required that the consent thereto of the Interstate Commerce Commission and the Public Utilities Commission of Ohio should be secured. Such consents were obtained on July 14 and August 19, 1924, respectively. The readjustment payments from the railroads were not completed until sometime thereafter and the Railway Co. did not become self-sustaining until the summer of 1925.
On May 22, 1925, the board of directors of the Cement Co. passed the following resolution:
WHEREAS, this Company discovered and later purchased a deposit of limestone near Silica, Lucas County, Ohio, of a quality suitable for the manufacture of Portland cement, and decided in the early part of 1922 to erect, at the location of such deposit, a plant for the manufacture of Portland cement; and
WHEREAS, the only line*1199 of railroad to Silica was the railroad of The Toledo, Angola & Western Railway Company, which was in such poor physical condition that it was unable to give industries along its line proper transportation service, and said Railway Company was insolvent and without financial means or credit to put its roadbed and equipment in condition for proper service; and
WHEREAS, it was necessary, if this Company built its plant at Silica, that said railroad should be put in condition to afford proper transportation facilities to said plant and to the public generally, and to that end it was deemed advisable that a reorganization be effected by the Company acquiring all of the outstanding stock and bonds of said Railway Company, with the intent of dividing and distributing the same among the stockholders of this Company, when said railroad should be put in condition to properly perform its duties as a common carrier; and
WHEREAS, in pursuance of the plan aforesaid, this Company acquired the capital stock and bonds of said Railway Company, and the shares of capital stock now stand in the name of and are now held in trust for this Company by the persons following, to-wit:
| E. J. Maguire | 1,515 shares |
| A. C. Dustin | 1,463 shares |
| J. B. John | 10 shares |
| G. W. Cole | 7 shares |
| John W. Eckelberry | 5 shares |
*1200 and
*31 WHEREAS, the improvements necessary to put said railroad into condition to enable it to carry out its duties as a common carrier, will now be completed at an early date;
Now, THEREFORE, BE IT RESOLVED, in accordance with and for the purpose of carrying out the plan under which the securities of said Railway Company were acquired by this Company, that a distribution be made proportionately to the stockholders of this Company at the close of business on the 25th day of May, 1925, to the extent of $291,856.00 par value in the stock of said Railway Company, that is to say 4/100ths of a share of the Railway Company's stock to each share of the 72,964 shares of this Company's stock now outstanding, and said E. J. Maguire and said A. C. Dustin, in whose names 2,978 shares of stock of said Railway Company are now standing as aforesaid, be and they are hereby directed to make out of said shares said distribution aforesaid to the stockholders of record of this Company on the date aforesaid; provided, however, that no fractional shares of said stock of said Railway Company shall be issued, but that as to such stockholders of this Company as would under the terms hereof be*1201 entitled to a fraction of a share of stock of said Railway Company, there shall be issued in the usual form a certificate by the Railway Company evidencing their respective fractional interests in the stock of the Railway Company; and provided further that A. C. Dustin shall, from the shares standing in his name, set aside and transfer for that purpose enough shares to equal the total aggregate amount of such fractional shares:
RESOLVED, FURTHER, that it is the sense of this Board of Directors that it is advisable that the 3,000 shares of Capital Stock of the Railway Company, of the par value of $100.00 each, now outstanding, should be converted into 3,000 shares of no par common stock;
RESOLVED, FURTHER, that it is the sense of this meeting that the present issue of $300,000.00 par value of 5% First Mortgage Gold Coupon Bonds of the Railway Company, owned by this Company and now outstanding, which matured on September 1, 1922, be refunded at the earliest practicable date into a new bond issue on such terms as meet the approval of the Public Utilities Commission of the State of Ohio and the Interstate Commerce Commission and that the proper officers of this Company be, and they*1202 are hereby directed to cooperate in every way possible to put thru said refunding plan at the earliest practicable date.
On June 1, 1925, the Railway Co. owed the Cement Co. $523,426.34, including the issue of $300,000 in first mortgage 5 percent bonds and interest thereon. The consent of the Interstate Commerce Commission was required in order to make the refunding provision effective. That consent was secured on November 4, 1925, with the stipulation that the Cement Co. should cancel all indebtedness over the $300,000 of first mortgage 6 percent bonds comprising the new refunding issue. Three thousand shares of common stock of no par value were also authorized to be issued in exchange for 3,000 shares of common stock of the par value of $100 each, then outstanding. In November 1925, the Railway Co. obtained an order of like tenor from the Public Utilities Commission of Ohio. The shares of common stock thereupon were so issued and distributed to the stockholders of the Cement Co.
*32 On November 24, 1925, the board of directors of the Cement Co. adopted the following resolutions:
WHEREAS, this Company is the owner of $300,000 par value of 5% bonds of the Toledo, *1203 Angola & Western Railway Company, which matured, by their terms, on September 1, 1922, and which were acquired by this Company in connection with all the shares of capital stock of said Railway Company under the conditions and for the purposes set forth in the certain resolution adopted at the meeting of this Board of Directors on the 22nd day of May, 1925; and
WHEREAS, since the date of said resolution and as provided therein said shares of stock of said Railway Company in par value to the amount of $291,856.00 have been distributed to stockholders of this Company on the basis of 4/100ths of a share of Railway Company stock to each of the 72,964 shares of this Company at that time outstanding; and
WHEREAS, the track and equipment of said Railway Company has been put into condition to enable it to properly carry on its business; and
WHEREAS, said Railway Company, on application duly made by it, has recently been authorized by the Interstate Commerce Commission and by the Public Utilities Commission of the State of Ohio to reorganize its capitalization, by converting its 3,000 shares of capital stock, of the par value of $100.00 each, into 3,000 shares of no par value stock, such*1204 no par shares to be exchanged share for share for the $100.00 par value shares of the Railway Company, and likewise by issuing $300,000, face value of its first mortgage 6% bonds, to be dated July 1, 1925, to mature July 1, 1945, secured by a first mortgage upon all the tangible assets and property of said Railway Company; provided that this Company would accept said $300,000. face value of said bonds in complete liquidation of the old 5% bonds and all other indebtedness of said Railway Company to this Company, except current monthly bills;
Now, THEREFORE, BE IT RESOLVED, That this Company does hereby accept said proposition and agrees to receive, on January 1, 1926, in exchange for and in liquidation of said indebtedness as aforesaid, said new bonds with the coupons for interest due on July 1, 1926, detached therefrom; and
RESOLVED, FURTHER, That this Company forthwith deliver said old 5% bonds dated July 25, 1902, to said Railway Company for cancellation and cremation, in order that said Railway Company may secure the discharge of record by the Trustee of the mortgage securing said old bonds, to the end that the proposed mortgage securing said new bonds may become a first line*1205 [sic.] on said railway property; and
RESOLVED FURTHER, That said officers be, and they hereby are, authorized and directed to cause to be converted into no par shares, the 81.44 shares of $100.00 each of the stock of the Railway Company still owned by this Company.
* * *
WHEREAS, this Company has, by resolution of the Board this day adopted, agreed to become the owner of $300,000. par value of the new 6% first mortgage bonds of The Toledo, Angola & Western Railway Company, dated July 1, 1925, and maturing on July 1, 1945; and
WHEREAS, said bonds are payable to bearer and this Company is willing, in any disposition thereof made by it, to guarantee payment thereof;
NOW, THEREFORE, BE IT RESOLVED, that this Company in consideration of the premises and its interest in said Railway Company, agrees to and does hereby guarantee to each and every person who may become lawful owner and holder of said bonds, the payment by The Toledo, Angola & Western Railway *33 Company of the principal and interest thereof, according to the terms of said bonds, and the several coupons, respectively attached thereon, as the same become due and payable;
RESOLVED, FURTHER, that the Secretary*1206 and Treasurer of this Company be, and he is hereby authorized and directed to endorse on said bonds the guarantee of this Company in the following words:
The undersigned Company hereby, for a valuable consideration, guarantees the payment of the principal and interest of the within bond.
THE SANDUSKY CEMENT COMPANY,
by E. J. MAGUIRE
Secy. & Treas.
and said Secretary is hereby directed to affix this Company's corporate seal to said endorsement.
* * *
WHEREAS, this Company will, at an early date, pursuant to the action taken by this Board this day, receive $300,000. face value of the First Mortgage Bonds of The Toledo, Angola & Western Railway Company, in the denominations of $1,000.00, $500.00 and $100.00 each, respectively;
NOW, THEREFORE, for the purpose of carrying out and completing the plan under which the securities of said Railway Company were acquired by this Company, as set forth in the Resolution of this Board, adopted on the 22nd day of May, 1925,
BE IT RESOLVED, That the officers of this Company be, and they hereby are, authorized and directed to distribute, on January 1, 1926, proportionately to the stockholders of record of this Company at the close*1207 of business on the 25th day of December, 1925, the bonds of the Railway Company so to be received by this Company as aforesaid, to the extent of $292,656.00 face value of said bonds; that is to say, $4.00 par value in said bonds to each share of the 72,164 shares of this Company's stock now outstanding; provided, however, that no fractional bonds shall be delivered under this Resolution, but that as to such stockholders of this Company as would, under the terms hereof, be entitled to a fractional part of a $100.00 bond, this Company, in order to adjust the same, buy from such stockholder for cash at 98% of face value of his fraction of such $100.00 bond, or at the option of such stockholder, he be permitted to buy at 98% of face value such fractional part of a $100.00 bond as will give him a full bond; and
RESOLVED FURTHER that the Treasurer of this Company be, and he is hereby authorized on the basis of 98% of face value, to use in such adjustment of fractional parts of bonds, so much as he may deem necessary of the $7,344.00 face value of such bonds still remaining in the Treasury after the above distribution.
* * *
On March 31, 1922, and May 22, 1922, the board of directors*1208 of the Cement Co. consisted of Frank Billings, J. H. Wade, Dan P. Eells, S. B. Newberry, Charles F. Brush, A. C. Dustin, E. S. Hanson, William B. Newberry and E. J. Maguire. The board retained the same personnel to November 24, 1925, with the exception of S. B. Newberry, who died and was replaced by J. B. John.
*34 Prior to March 28, 1922, the directors had agreed upon the policy of distributing proportionately among its stockholders the securities of the Railway Co. if and when acquired. During the negotiations carried on between the officers and the directors of the Cement Co. and the officers of the Railway Co., on the one hand, and officials of the 14 trunk lines in Toledo on the other, the officers and directors of the Cement Co. made the positive and definite representation, upon which the trunk line officials relied, that the acquisition of the Railway Co. stock and bonds by the Cement Co. had been made with the direct purpose and obligation of divesting the Cement Co. of the ownership thereof means of distributing such securities to the stockholders of the Cement Co. in proportion to their holdings.
The first mortgage 6 percent bonds of the Railway Co. were issued*1209 and distributed as provided in the resolution of November 24, 1925. In the calendar year 1926 and for many years prior thereto the decedent was a stockholder in the Cement Co. As such stockholder and without the surrender by her of any stock or securities in either the Cement Co. or the Railway Co., or any other company, she received from the Cement Co., on January 1, 1926, as her proportionate part of the distribution of the above described first mortgage 6 percent bonds of the Railway Co. dated July 1, 1925, bonds of the par value of $9,704. The fair market value on January 1, 1926, of such bonds so received by the decedent was $8,910.08. The respondent determined that such distribution of the railway bonds to the decedent was a dividend by the Cement Co. and as such constituted taxable income to her in the amount of their fair market value on January 1, 1926.
On January 1, 1926, the Cement Co. had an earned surplus in excess of $300,000 accumulated since February 28, 1913. In the years 1923, 1924, and 1925 the Cement Co. paid cash dividends amounting in the aggregate to $213,892, $437,409, and $731,005, respectively.
OPINION.
SMITH: Section 203(c) of the Revenue Act*1210 of 1926 provides:
If there is distributed, in pursuance of a plan of reorganization, to a shareholder in a corporation a party to the reorganization, stock or securities in such corporation or in another corporation a party to the reorganization, without the surrender by such shareholder of stock or securities in such a corporation, no gain to the distributee from the receipt of such stock or securities shall be recognized.
Article 1576, Regulations 69, cited by both the petitioner and the respondent, is as follows:
Receipt of stock or securities in reorganization. - If, without any surrender of his stock or securities, a shareholder in a corporation a party to a reorganization receives in pursuance of the plan of reorganization stock or securities *35 in such corporation or in another corporation a party to the reorganization, no gain to the shareholder will be recognized.
Section 203(h) of the Revenue Act of 1926 defines the terms material to the issue in the case at bar, as used in section 203(c), in the following language:
(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority*1211 of the voting stock and at least a majority of the total number of shares of all other classes of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form or place of reorganization, however effected.
(2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation.
The petitioner contends that the bonds received by decedent in 1926 as a stockholder of the Sandusky Cement Co. are exempt from income tax upon the ground that they were distributed to her "in pursuance of a plan of reorganization" under section 203(c) of the Revenue Act of 1926. Whether this be so depends upon the interpretation given*1212 to section 203(h)(1)(A) of the Revenue Act of 1926 quoted above. In , the Supreme Court, referring to this language, said:
* * * The words within the parenthesis may not be disregarded. They expand the meaning of "merger" or "consolidation" so as to include some things which partake of the nature of a merger or consolidation but are beyond the ordinary and commonly accepted meaning of those words - so as to embrace circumstances difficult to delimit but which in strictness cannot be designated as either merger or consolidation. But the mere purchase for money of the assets of one Company by another is beyond the evident purpose of the provision, and has no real semblance to a merger or consolidation. Certainly, we think that to be within the exemption the seller must acquire an interest in the affairs of the purchasing company more definite than that incident to ownership of its short term purchase money notes. This general view is adopted and well sustained in *1213 . It harmonizes with the underlying purpose of the provisions in respect of exemptions and gives some effect to all the words employed. [Italics supplied.]
From our findings it is to be noted that the Sandusky Cement Co. acquired all of the capital stock and bonds of the Railway Co. in 1922. This was an outright purchase. The stockholders and bondholders of the Railway Co. received cash and short term notes in payment for the securities sold. They did not acquire any *36 interest in the affairs of the purchasing company. The 3,000 shares of par value stock of the Railway Co. were changed into a like number of shares of no par value and a new issue of bonds supplanted the old issue. But this was not a part of the original plan and although it might be a reorganization of the Railway Co. under section 203(h)(1)(C), nevertheless, it is not the reorganization relied upon by the petitioner and would not support petitioner's case in any event. Most of the capital stock of the Railway Co. was distributed to the Cement Co.'s stockholders in 1925 and the bonds were distributed*1214 to the stockholders in 1926. There was clearly no "reorganization" of the companies within the interpretation of the pertinent language of section 203(h)(1) of the Revenue Act of 1926 as interpreted by the Supreme Court.
It appears to us that there is no ground for holding the decedent exempt from income tax in respect of the fair market value of the bonds received, the value of which is not in question. The decision of the United States Supreme Court in , is determinative of this issue.
Reviewed by the Board.
Judgment will be entered for the respondent.
TRAMMELL dissents.
VAN FOSSAN, dissenting: The prevailing opinion in this case turns solely on the ground that when the Cement Co. acquired 100 percent of the stock and bonds of the Railway Co. there was no reorganization under the statute. It may be pertinent first to point out that neither in the notice of deficiency, nor in the pleadings, nor at the hearing, has respondent ever ever questioned the fact that there was a statutory reorganization in 1922. The sole issue to which the attention of the parties has been addressed is*1215 whether or not the distribution of bonds in 1926 came under section 203(c) of the Revenue Act of 1926, and the contention of respondent is that the distribution was made at such a time and in such a manner as to constitute the payment of a dividend and not a distribution "in pursuance of a plan of reorganization."
Section 203(h)(1) provides:
(h) As used in this section and sections 201 and 204 -
(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected.
*37 The Cement Co. acquired all of the stock of the Railway Co. How then can it be held that this fact did not bring*1216 the transaction within the express terms of the statute? The prevailing opinion cites the decision of the Supreme Court in . With all respect it is submitted that this case, so far as pertinent at all, supports the exact opposite of the majority view. When the Pinellas case was before the Board it was held that the transaction was merely a sale of assets for money and did not partake of the nature of a statutory reorganization. The circuit court of appeals affirmed this decision (), but went beyond the necessity of the case and expressed certain dicta as to the interpretation of the statutory definition of a reorganization. When the case came before the Supreme Court on certiorari, that Court, after affirming the holding as to the character of the transaction, took occasion to point out that the dictum of the circuit court was too narrow and might prove perplexing. The Court proceeded to point out the error in the opinion of the Circuit Court and stated, in effect, that the parenthetical clause in section 203(h)(1)(A) worked an enlargement of the terms "merger" or "consolidation" *1217 beyond their ordinary meaning. Returning to the situation in the case before them, the court expressed the thought on which the author of the prevailing opinion in this proceeding, as indicated by italics, places chief emphasis. But when the expression of the Supreme Court is read in its context it is readily seen that it has no pertinence here. The Court was addressing itself to a situation in which there had been a sale of assets for cash or its equivalent. The same factual situation obtained in , which the Supreme Court cited with approval. In the instant case we have the acquisition of all of the stock and bonds of one company by another company. It is not necessary to employ the liberty of interpretation authorized by the Supreme Court. The present case comes within the very language of the statute. Where a case falls squarely within the provisions of a statute it is not for this Board or the courts to write it out by assuming analogy to a different case.
It may be that some of the confusion in this case arises from the thought that the transaction here does not look like a "reorganization" *1218 as popularly understood. But we are concerned not with the popular definition or conception, but with the statutory definition, a very different thing. Whether this transaction was a "merger" or a "consolidation" at common law is not the question. The question is does it come within the statutory definition, especially the parenthetical clause which the Supreme Court has said enlarges the scope of the terms used. Believing that it does, I must dissent.
*38 By reason of the thesis on which the case is made to turn, no consideration is given to the proposition on which this case was submitted, i.e., the character of the distribution of the bonds. On this question I have no doubt of the correctness of petitioner's position. Accordingly I am of the opinion that judgment should have been for the petitioner.