1951 U.S. Tax Ct. LEXIS 43">*43 Decisions will be entered under Rule 50.
During period in which railroad corporation was in the process of reorganization, a partnership composed of petitioners purchased outstanding bonds of the corporation and entered into "when issued" contracts for the purchase and sale of new securities to be issued upon consummation of the reorganization. On the settlement date, the partnership satisfied its "when issued" sales contracts by simultaneously delivering its "when issued" purchase contracts plus new securities received in exchange for the old bonds. It was not possible to identify any particular securities sold with any particular securities acquired. Held, proper method of determining the amount of long or short term capital gain realized, or long or short term capital loss sustained, is to match the earliest "when issued" sales contracts with the securities sold in the order of their dates of acquisition.
17 T.C. 772">*772 The respondent determined deficiencies in the income tax of petitioners for the calendar year 1945 as follows: Raymond B. Haynes, $ 594.39; Herbert G. Wellington, $ 14,786.03. The sole question presented for decision is the correct method for determining, in 1944, the amount of long or short term capital gain realized, or long or short term capital loss sustained, where several contracts to sell securities "when issued" are entered into at various times and prices and where such contracts are satisfied on the settlement date in part by "when issued" purchase contracts theretofore entered into, and in part by the delivery of securities of the reorganized corporation, some of which were acquired in exchange for bonds of the reorganizing corporation, and some for interest accrued on such bonds. The year in litigation, 1945, is involved only by reason of a capital 1951 U.S. Tax Ct. LEXIS 43">*45 loss carry-over from 1944.
FINDINGS OF FACT.
A stipulation of facts was filed, which is hereby adopted as our findings, and which is substantially as follows:
At all times during the taxable years 1943 to 1945, the petitioners 1 were, and continue to be, partners in the stock brokerage firm doing business under the name of Wellington & Co. at 120 Broadway, New York City.
17 T.C. 772">*773 During 1943 and 1944, Wellington & Co. (hereinafter referred to as the "partnership") traded extensively in new securities of the reorganized Chicago & North Western Railway Company on a "when, as, and if issued" basis and reported a long term capital gain of $ 38,451.98 and a short term capital loss of $ 859,761.89 on these transactions in its income tax return for the calendar year 1944.
Trading in securities on a "when, as, and if issued" basis takes place after a plan of reorganization1951 U.S. Tax Ct. LEXIS 43">*46 of a corporation has been submitted that provides for the issuance of securities of a new corporation or of new securities of the reorganized old corporation in exchange for its outstanding securities. Before such a plan of reorganization actually becomes effective, the approval of interested security holders must be obtained or the plan must be approved by regulatory bodies or the courts. There is often litigation as a result of which the plan of reorganization may be abandoned or approved in a modified form. The time elapsing between the submission of the plan and the actual exchange of old securities for new securities under the plan, or the plan as modified, may be as much as several years. After the submission of the plan of reorganization, trading may be commenced in the new securities which are to be issued under the plan of reorganization. Inasmuch as these securities are not in existence, and will never come into existence if the plan of reorganization is not carried out, the trading is on the basis of "when, as, and if issued" and is carried on by the execution of contracts for the purchase and sale of the new securities "when issued" at prices specified therein. "When1951 U.S. Tax Ct. LEXIS 43">*47 issued" sales contracts are merely agreements to sell the new securities at a specified price, under which the contracting party acquires only the right to sell those securities at that price when they are issued. "When issued" purchase contracts are merely agreements to buy the new securities at a specified price, under which the contracting party acquires only the right to buy those securities at that price when they are issued. No actual sale or purchase is effected under a "when issued" contract until the new securities are issued.
When securities are admitted to dealings on the New York Stock Exchange on a "when issued" basis, the contracts for the purchase and sale of these securities must follow a form prescribed by the Exchange by the terms of which the new securities are not deemed to be issued until the date proclaimed by the Exchange for the settlement of all "when issued" security transactions. This "settlement date" is the date on which the new securities must be delivered in satisfaction of all "when issued" contracts containing the terms prescribed by the Exchange. No actual sale of securities sold under such contracts takes place until this settlement date.
On 1951 U.S. Tax Ct. LEXIS 43">*48 the settlement date, "when issued" contracts of the type described in the preceding paragraph may be satisfied by the physical 17 T.C. 772">*774 delivery of new securities between the contracting parties, their assignees or their brokers, or, if the contracting parties or their brokers are members of the Stock Clearing Corporation (a subsidiary of the New York Stock Exchange), the contracts must be cleared or settled through the Stock Clearing Corporation depending upon whether the trading is heavy or light. If the volume of trading in the "when issued" securities is unusually heavy the Stock Clearing Corporation orders a clearance of said securities; otherwise, said contracts are settled individually by the Stock Clearing Corporation. When a clearance is held the contracting parties or their brokers report their contracts to the Stock Clearing Corporation where the total "when issued" sales contracts are applied in bulk against the total "when issued" purchase contracts without identification as to the application of any particular "when issued" purchase contract against any particular "when issued" sales contract. Where the trading is unusually heavy the Stock Clearing Corporation may1951 U.S. Tax Ct. LEXIS 43">*49 order intermediate clearances similar to the above-described final clearance, and in that case any excess of sales over purchases (or vice versa) are carried forward to the final clearance at the clearance price. On the settlement date a final clearance is held and a final balance to deliver (or receive) at the final "clearance price" is determined in the manner described above. If the trader's "when issued" sales exceed his "when issued" purchases on this date, he or his broker is directed to deliver new securities to persons designated by the Stock Clearing Corporation (who may or may not be persons with whom the trader has contracted) in satisfaction of the excess. Under a clearance settlement of this nature, the new securities delivered in satisfaction of the excess of the "when issued" sales contracts over the "when issued" purchase contracts, are delivered in bulk without identification as to their application in satisfaction of any particular "when issued" sales contract.
Prior to the consummation of the plan of reorganization of the Chicago & North Western Railway Company on June 1, 1944 (hereinafter referred to as the "Chicago & North Western"), the partnership, at various1951 U.S. Tax Ct. LEXIS 43">*50 times and various prices entered into contracts for the sale of new securities of the reorganized company "when issued" in the following amounts:
(a) 1,503,272 Bonds (C & NW First and General 4's 1989)
(b) 3,033,410 Bonds (C & NW Second Income 4 1/2's 1999)
(c) 39,240.95 Shares of C & NW Preferred Stock
(d) 19,966.14 Shares of C & NW Common Stock
At various times and at various prices the partnership entered into contracts for the purchase of new securities of the reorganized company "when issued" in the following amounts:
17 T.C. 772">*775 (a) 167,746 Bonds (C & NW First and General 4's 1989)
(b) 411,223 Bonds (C & NW Second Income 4 1/2's 1999)
(c) 13,353.30 Shares of C & NW Preferred Stock
(d) 7,633.23 Shares of C & NW Common Stock
From October 1943 through May 1944 the prices of each new security sold "when issued," according to the partnership's records, were within the following range:
| Low | High | |
| New common | 15 1/2 | 28 1/2 |
| New preferred | 37 1/2 | 58 1/2 |
| New bonds second income 4 1/2's 1999 | 477.50 | 688.75 |
| New bonds first and general 4's 1989 | 920.00 | 1,050.00 |
At various times and various prices in the period prior to the "settlement date," the partnership purchased and1951 U.S. Tax Ct. LEXIS 43">*51 sold old bonds of the Chicago & North Western and its affiliated companies which, pursuant to the plan of reorganization, would be exchangeable for new securities of the reorganized company in various proportions. On the consummation of the reorganization, the partnership received new securities in exchange for the unsold portion of these bonds. These new securities were used to satisfy the excess of its "when issued" sales contracts over its "when issued" purchase contracts.
The Bureau of Internal Revenue ruled that the consummation of the plan of reorganization of the Chicago & North Western on June 1, 1944, constituted a tax-free reorganization to the extent that new securities of the reorganized company were received in exchange for principal of the bonds of the Chicago & North Western. On the basis of this ruling, the dates of acquisition of the new securities of the reorganized company that were received in exchange for principal of bonds of the Chicago & North Western and used to satisfy the partnership's "when issued" sales contracts were the dates of purchase of the bonds. The date of acquisition of the new securities of the reorganized company that were received for 1951 U.S. Tax Ct. LEXIS 43">*52 interest on bonds of the Chicago & North Western and used to satisfy the partnership's "when issued" sales contracts was June 1, 1944 -- the date of the consummation of the plan of reorganization.
The settlement date for all "when issued" transactions in the new securities of the reorganized company was July 24, 1944, as proclaimed by the New York Stock Exchange.
No actual sale of securities sold under the partnership's "when issued" sales contracts took place until July 24, 1944, on which date there was a simultaneous sale through the Stock Clearing Corporation, at different prices, of all the new securities acquired under the partnership's "when issued" purchase contracts and received in exchange for the principal of and interest on bonds of the Chicago & North Western held by the partnership.
17 T.C. 772">*776 The Stock Clearing Corporation prescribed intermediate and final clearances for these securities because of the heavy trading, and the partnership's "when issued" contracts were cleared in accordance with the usual procedure, the final clearance being held on July 24, 1944.
In determining the gains or losses realized on the settlement date by the simultaneous sale, at different prices, 1951 U.S. Tax Ct. LEXIS 43">*53 of securities acquired at different times and different prices, the partnership totaled the sales prices of each new security of the reorganized company and divided this amount by the total number of new securities sold under the "when issued" sales contracts in order to arrive at an "average sales price" per security. This "average sales price" was used to determine the short term gains or losses realized on the settlement of "when issued" sales contracts with "when issued" purchase contracts and to determine the long term or short term gains or losses realized on the settlement of "when issued" sales contracts by the delivery of actual new securities (received in exchange for bonds of the Chicago & North Western) which had been acquired more or less than six months prior to July 24, 1944.
The respondent computed the amount of profit or loss realized by the partnership on the settlement of its "when issued" sales contracts by chronologically listing the "when issued" sales contracts in the sequence in which they were executed and by listing the "when issued" purchase contracts and actual securities used to satisfy the sales contracts, interspersing them chronologically according1951 U.S. Tax Ct. LEXIS 43">*54 to the following acquisition dates:
(a) For new securities received on reorganization for principal of bonds of the reorganizing company purchased on or before January 23, 1944 (i. e., more than six months prior to the settlement date) -- the dates of purchase of the bonds;
(b) For new securities received on reorganization for interest on bonds of the reorganizing company purchased on or before January 23, 1944 -- the dates of purchase of the bonds;
(c) For securities purchased under "when issued" purchase contracts executed on or before January 23, 1944 -- the dates of execution of the contracts.
The sales prices of securities sold under each "when issued" sales contract were then applied against the cost prices of the securities either purchased under each "when issued" purchase contract or received in exchange for the principal of and interest on bonds of the reorganizing company, on a "first in, first out" basis. The sales prices of securities sold under the balance of the "when issued" sales contracts were applied against the cost prices of the balance of the securities acquired after January 23, 1944, under "when issued" purchase contracts executed after that date or received1951 U.S. Tax Ct. LEXIS 43">*55 in exchange for bonds of the reorganizing company purchased after that date on a "first in, first out" basis in the manner described above.
17 T.C. 772">*777 In determining whether the amount of profit or loss so computed constituted long term or short term gain or loss, the respondent used the following acquisition dates for the securities used to satisfy the partnership's "when issued" sales contracts:
(a) For new securities received on reorganization for principal of bonds of the reorganizing company -- the dates of purchase of the bonds;
(b) For new securities received on reorganization for interest on bonds of the reorganizing company -- June 1, 1944 (the official date of the consummation of the plan of reorganization);
(c) For securities purchased under "when issued" purchase contracts -- July 24, 1944 (the settlement date).
Through the use of the method described in the two preceding paragraphs, the respondent determined that the partnership realized a long term capital loss of $ 18,719.09 and a short term capital loss of $ 802,590.82 on the settlement of its "when issued" sales contracts. This represented a decrease of $ 57,171.07 in the partnership's reported long term capital1951 U.S. Tax Ct. LEXIS 43">*56 gain and a decrease of $ 57,171.07 in its reported short term capital loss.
OPINION.
On the settlement date, July 24, 1944, the partnership satisfied its "when issued" sales contracts in part by "when issued" purchase contracts and in part by the actual delivery of securities in the reorganized corporation which it had obtained in exchange for bonds of old corporation that it had previously purchased at various times and at various prices. Were it not for the capital gains and loss provisions, it would be a simple matter to determine the tax consequences of these transactions: it would be sufficient merely to subtract the cost of the various "when issued" purchase contracts and the cost of all of the bonds from the total amount realized on the "when issued" sales contracts in order to arrive at the net gain or loss. However, by reason of the capital gains and loss provisions, it becomes necessary to determine how much was received for securities held more than six months and how much was received for the securities held for six months or less.
There is no question here as to the cost of the particular securities sold, nor is there any dispute between the parties as to how long such1951 U.S. Tax Ct. LEXIS 43">*57 securities were held prior to sale. 2
17 T.C. 772">*778 The only problem is to allocate the total sales proceeds between the securities1951 U.S. Tax Ct. LEXIS 43">*58 held for more than six months and those held for six months or less. By reason of the manner in which the settlements were carried out, it was impossible to identify any particular securities or "when issued" purchase contracts with any corresponding "when issued" sales contracts. In the circumstances, it was necessary to adopt some arbitrary method of allocation. The difference between the parties relates to the method to be employed. The partnership computed an average sales price which was applied to all the securities involved, whereas the Commissioner used the actual sales prices and undertook to match them with the various securities sold, allocating the sales prices under the earliest "when issued" sales contracts to the securities first acquired, 3 and so forth.
1951 U.S. Tax Ct. LEXIS 43">*59 The method employed by the Commissioner is similar to the one used where securities acquired by a taxpayer at different costs and different times are commingled so that a sale of a part thereof cannot be identified as being from any particular purchase. In the latter circumstances, the so-called first in, first out rule requires that, in the absence of identification, the sale be charged against the earliest purchases. Snyder v. Commissioner, 295 U.S. 134">295 U.S. 134; Helvering v. Rankin, 295 U.S. 123">295 U.S. 123; Helvering v. Campbell, 313 U.S. 15">313 U.S. 15, 313 U.S. 15">20; Skinner v. Eaton (C. A. 2), 45 F.2d 568; Snyder v. Commissioner (C. A. 3), 54 F.2d 57; Commissioner v. Merchants' & Mfrs.' Ins. Co. (C. A. 3), 72 F.2d 408; Perkins v. United States (Ct. Cls.), 12 F. Supp. 481">12 F. Supp. 481; Keeler v. Commissioner (C. A. 8), 86 F.2d 265, certiorari denied 300 U.S. 673">300 U.S. 673; Kraus v. Commissioner (C. A. 2), 88 F.2d 616;1951 U.S. Tax Ct. LEXIS 43">*60 Towne v. McElligott (S. D., N. Y.), 274 F. 960">274 F. 960, 274 F. 960">963.
The "first in, first out" rule is not a new one, nor was it devised for tax cases. It has its origin in the more distant past. As Judge Learned Hand remarked in 274 F. 960">Towne v. McElligott, supra, at p. 963: "The most natural analogy is with payment upon an open account, where the law has always allocated the earlier payments to the earlier debts, in the absence of a contrary intention." 4 Although the rule has at times been criticized (cf. Arrott v. Commissioner, 136 F.2d 449, 451), it has nevertheless been widely followed, and normally furnishes a 17 T.C. 772">*779 satisfactory and fair solution where the precise facts are not susceptible of ascertainment. Treasury regulations have provided for many years that where shares of stock in a corporation are sold from lots purchased at different times or at different prices, the stock sold is to be charged against the earliest purchases if the identity of the lots cannot be determined. See Regulations 111, sec. 29.22 (a)-8 and corresponding provisions of prior regulations.
1951 U.S. Tax Ct. LEXIS 43">*61 This case does not, of course, fall within the literal terms of the regulations, because we do not have before us the problem of which securities were sold. All of the securities were sold here, and the problem is to match selling prices with the particular securities sold. The petitioners appear to argue that since the regulations are not applicable, any rule comparable to the "first in, first out" rule is forbidden. But there is nothing in the regulations that is so limiting; and there is nothing in the regulations that prohibits the use of a comparable formula in a situation not strictly within the terms of the regulations, where such is not precluded by the statute. Cf. Helvering v. Campbell, 313 U.S. 15">313 U.S. 15, 313 U.S. 15">21, fn. 5.
Petitioners place heavy reliance upon a line of decisions applying an "averaging" rule rather than the "first in, first out" rule, in order to determine the basis of securities in a new corporation received in a tax-free reorganization in exchange for different lots of securities in an old corporation, each such old lot having a different basis. See, e. g., Helvering v. Stifel (C. A. 4), 75 F.2d 583;1951 U.S. Tax Ct. LEXIS 43">*62 Christian W. Von Gunten, 28 B. T. A. 702, affd. (C. A. 6) 76 F.2d 670; Commissioner v. Oliver (C. A. 3), 78 F.2d 561; Commissioner v. Bolender (C. A. 7), 82 F.2d 591; Arrott v. Commissioner (C. A. 3), 136 F.2d 449; Raoul H. Fleischmann, 40 B. T. A. 672, 687-688. Cf. Big Wolf Corporation, 2 T.C. 751. But that line of cases constitutes an exception to the "first in, first out" rule. The result in such cases has been explained in terms of particular statutory provisions governing such situations (see Christian W. Von Gunten, 28 B. T. A. 702, 704), and the Court of Appeals for the Second Circuit in Kraus v. Commissioner, 88 F.2d 616, 618, has refused to extend it to a related situation, where there was no change in corporate identity and where the old and the new securities were issued by the same corporation. 5 But whatever may be the precise scope of those decisions, we find nothing in them1951 U.S. Tax Ct. LEXIS 43">*63 that precludes the matching of the prices under the "when issued" sales contracts chronologically with the costs of the securities sold in the order of their acquisition.
Petitioners contend that the method of matching the cost or basis of the first acquired securities with the price on the earliest "when issued" 17 T.C. 772">*780 sales contract is "arbitrary" and "contrary to fact." However, we think it is no more "arbitrary" than the method proposed by petitioners. Indeed, their method would employ a wholly fictitious sales price, computed by averaging all the sales, whereas the Commissioner's method more nearly approaches the truth by using the actual prices received. Nor is the Commissioner's method "contrary to fact" in treating the sales as consummated on the dates the "when issued" sales contracts were executed, when in fact such sales actually occurred1951 U.S. Tax Ct. LEXIS 43">*64 simultaneously on the settlement date ( Lewis K. Walker, 35 B. T. A. 640). His method does not treat the sales as consummated on the dates the "when issued" sales contracts were executed; on the contrary, he recognizes that the sales were made simultaneously on the settlement date, and it is only because of that fact that it is impossible to identify particular sales with specific securities, with the consequence that some method must be employed to determine the sales prices of the various securities sold. And we think that matching sales contracts with securities chronologically is as reasonable as any other method that has been suggested. We certainly cannot say that this method is wrong.
Although we approve the Commissioner's method generally, we disapprove the manner in which it was used in certain respects. Ordinarily, the dates of acquisition for the purpose of determining the holding period are the same dates of acquisition for the purpose of applying the "first in, first out" rule. Helvering v. Campbell, 313 U.S. 15">313 U.S. 15, 313 U.S. 15">21; Regulations 111, sec. 29.22(a)-8. However, the Commissioner, as pointed out in footnote1951 U.S. Tax Ct. LEXIS 43">*65 3, supra, departed from this principle in connection with the new securities received in exchange for interest on the old bonds and new securities attributable to the "when issued" purchase contracts. We see no reason for applying any fictitious or arbitrary order of dates of acquisition; the dates of acquisition for holding period purposes are known and they should be the same dates for purposes of matching sales prices against the securities sold. 6 With this modification, we approve the method employed by the Commissioner.
1951 U.S. Tax Ct. LEXIS 43">*66 Decisions will be entered under Rule 50.
Footnotes
1. Petitioners filed their respective income tax returns for the calendar year 1945 with the collector of internal revenue for the second district of New York.↩
2. Since the new securities obtained for the principal of the old bonds were received tax-free in a reorganization, they were deemed to take over the holding period of the old bonds. Thus, the securities derived from the principal of bonds purchased on or before January 23, 1944, had a holding period of more than six months on July 24, 1944, the date of sale. But the new securities obtained for interest on the old bonds were not received tax-free, and their holding period has been fixed to begin on June 1, 1944, the date of final approval of the reorganization. And since the securities attributable to the partnership's "when issued" purchase contracts cannot be treated as acquired prior to the settlement date (cf. Lewis Walker, 35 B. T. A. 640, 644-645; I. T. 3721, 1945 C. B. 164↩), their holding period began on the very date of sale.
3. In fixing the dates of acquisition for this purpose, the Commissioner departed in two respects from the dates of acquisition used in computing the holding periods: (a) as to securities obtained for interest on the old bonds, he used the dates of acquisition of the bonds, rather than June 1, 1944; and (b) as to "when issued" purchase contracts, he used the dates of the execution of the contracts, rather than July 24, 1944.↩
4. The next sentence in Judge Hand's opinion reads: "Accordingly, if all the new shares were not sold at once, I think the first sales should be attributed to the first purchases still remaining unsold * * *." The petitioners rely upon this sentence to support their contention that the "first in, first out" rule cannot apply where, as here, all the securities were sold at once. But in the situation presented in Townev. McElligott↩ there would be no problem requiring identification if the shares were all sold at one time, and we think that is all that Judge Hand meant by the quoted language. It certainly doesn't suggest that a comparable rule would be inapplicable, even if all the sales were simultaneous, where it becomes necessary to match selling prices against particular purchases.
5. The Kraus case was neither cited by the parties nor apparently was it considered by the Court in Big Wolf Corporation, 2 T.C. 751↩.
6. Of course, if it should be necessary to establish a sequence as between securities acquired on the same day, then it might be possible to adopt some such device as was spelled out in G. C. M. 11743, XII-2 C. B. 31, involving shares of stock acquired on the same day through the exercise of stock rights, whereby subsequent sales were related first to the rights growing out of the earliest purchase of the parent stock. Cf. Perkins v. United States (Ct. Cls.), 12 F. Supp. 481">12 F. Supp. 481, certiorari denied 297 U.S. 710">297 U.S. 710↩. Thus, if it were necessary to establish a sequence as between different securities acquired on June 1, 1944, in exchange for interest on the old bonds, it might be feasible to relate such securities back to the dates of acquisition of the bonds themselves. But no such problem is here presented, since all of the securities thus acquired in exchange for bond interest were sold within less than six months.