*1030 1. Where two corporations merge or consolidate to form a new corporation, and thereafter shares of the new corporation acquired as a result of the ownership of shares in one of the old corporations are sold, no identification of shares exchanged being proved, the basis for gain or loss on the new shares is the total cost of the old shares divided by the number of new shares. Christian W. Von Gunten,28 B.T.A. 702">28 B.T.A. 702; affd., 76 Fed.(2d) 670, followed.
2. Basis for apportionment between capital net gain and ordinary gain determined.
*458 This proceeding was brought for a redetermination of a deficiency in petitioner's income tax for the taxable year 1931 in the sum of $21,243.03. The issue involves the cost basis 1 for certain stock transferred by petitioner which had been acquired by him in a tax-free reorganization. Respondent based his notice of deficiency on the "first in, first out" rule but now seeks to apply the so-called "average cost" basis, and determines the deficiency in tax to be $21,288.60. Dependent*1031 upon the outcome of the first issue, there is a potential secondary issue concerning the portion of the gain to be considered as capital gain.
FINDINGS OF FACT.
On December 29, 1931, petitioner transferred 10,000 shares of class A common stock of the International-Stacey Corporation, some times *459 hereinafter called the new company, to Joseph H. Frantz, his father-in-law, in consideration of the cancellation of petitioner's note for $100,000 which was held by Frantz and was secured in part by the stock transferred.
Petitioner had received these shares, together with other shares, in a nontaxable reorganization hereinafter described, whereunder he had surrendered 4,900 shares of the preferred stock and 6,000 shares of the common stock of the International Derrick & Equipment Co., hereinafter sometimes called the old company. The preferred stock had been acquired by petitioner in 1930 at a total cost of $490,000 and the common stock had been acquired several years prior at a cost of $350,000.
The capital structure of the old company immediately prior to the reorganization was as follows:
| Bonds outstanding | $750,000 Owned by Battelle estate |
| Preferred stock, $100 par, 5,700 shares issued and outstanding | $570,000 4,900 shares purchased by petitioner at $100 per share; 800 shares held by J. J. Leidecker |
| Common stock, no par value, 6,000 shares issued and outstanding | All owned by petitioner; acquired at cost of $350,000 |
*1032 The Stacey Engineering Co., with whom the reorganization was effected, had 14,545 shares of $100 par value preferred stock outstanding. In addition, they had outstanding certain class A and class B stock which is not here material.
Petitioner had no interest in Stacey Engineering Co., and the Stacey Engineering Co. had no interest in the old company.
The preferred stock in the old company had been paying a 6 percent dividend regularly; its common stock had never paid a dividend, nor had any shares of common stock ever been sold.
In March 1931 petitioner, together with his attorney, and representatives of the stockholders of the Stacey Engineering Co. met at St. Augustine, Florida, for the purpose of considering the merger of the Stacey Engineering Co. with the International Derrick & Equipment Co. A tentative agreement to this end was put in writing on March 31, 1931. This agreement provided that the capital structure of the International Derrick & Equipment Co. should be increased to consist of:
(a) 30,000 shares of first preferred ( $100 par) to be issued in series; the first series to consist of $750,000 par value (7500 shares), convertible into Class A stock "at*1033 the rate 5 shares of Class A stock for one share of the par value of $100 for said preferred stock."
(b) Common stock of 500,000 shares of Class A stock, without par value and 300,000 shares of Class B stock without par value.
*460 The tentative agreement further provided that petitioner was to receive 38,750 shares of class A in exchange for the present outstanding preferred stock amounting to $570,000 par value, and was also to be provided with stock necessary in making an adjustment with the Leidecker Bondholders Protective Committee. (Petitioner was treated as the owner of 5,700 shares of preferred although 800 shares belonged to Leidecker.)
The shares which were allocated to petitioner were allocated on the basis of 24,500 shares for himself for his 4,900 shares of preferred stock in the old company; 4,000 shares to be given to J. J. Leidecker for the 800 shares of preferred stock held by him, and 10,250 shares to be used in the adjustment with the Leidecker Bondholders Protective Committee.
The agreement also comprehended that in addition petitioner was to receive 125,000 shares of class A and 125,000 shares of class B stock in exchange for his 6,000 shares*1034 of old company common stock.
The other parties to this tentative agreement represented the stockholders of the Stacey Engineering Co., who were to receive 72,725 shares of class A stock for the retirement of 14,545 shares of preferred stock of the Stacey Engineering Co. and were also to receive 100,000 shares class A and 163,500 shares of class B stock in payment for all Stacey Engineering Co. assets.
In April 1931 J. J. Leidecker agreed to accept 4,000 shares of the class A stock for his 800 shares of preferred stock in the International Derrick & Equipment Co. if other preferred stockholders agreed to do likewise.
Appropriate action was taken by both companies and on April 21, 1931, they entered into an agreement affirming in substance the tentative agreement above set out. At the suggestion of the parties acting for the Stacey Engineering Co., the number of class A shares which, together with class B stock, were to be issued in exchange otherwise than for preferred stock of the two companies was increased by 4,000 shares to each group. Petitioner, therefore, was to receive 129,000 shares of class A and 125,000 shares of class B in exchange for his 6,000 shares of old*1035 company common stock.
The agreement of April 21, 1931, gave the International Derrick & Equipment Co. an option to incorporate a new corporation rather than make the proposed changes in its own capital structure. Pursuant to this option, the International-Stacey Corporation was formed.
The three companies, by agreement, confirmed the April 21, 1931, agreement between the International Derrick & Equipment Co. and the Stacey Engineering Co. The actual exchange of shares by petitioner occurred on June 18, 1931, at which time petitioner's 4,900 *461 shares of old company preferred and 6,000 shares of old company common were located as follows:
| Preferred | Common | |
| At Huntington National Bank, as collateral for $200,000 note | 2,000 | 200 |
| With J. H. Frantz, as collateral for $100,000 note | 2,900 | 500 |
| In petitioner's safety deposit box in Huntington National Bank | 5,300 | |
| Total | 4,900 | 6,000 |
Just prior to the exchange, petitioner had arranged with the Huntington National Bank to substitute 30,000 shares of class A stock of the new company for the collateral held by the bank. The bank was transfer agent for the new company.
On June 18, 1931, petitioner, *1036 accompanied by his secretary, went to Frantz's office on the eleventh floor of the Huntington National Bank Building. The banking rooms were on the ground floor and the safety boxes and the bank's office as transfer agent were in the basement.
Petitioner instructed his secretary to go to his safety deposit box and take out the 5,300 shares of common stock of the old company and leave them with the transfer agent; she was instructed to obtain from the transfer agent 30,000 shares of class A stock of the new company, which she was to take upstairs to the banking rooms of the Huntington National Bank and substitute these 30,000 shares of class A for the 2,000 shares of preferred and 200 shares of common stock of the old company, in accordance with petitioner's agreement with the bank; she was then to bring the 2,000 shares of preferred and 200 shares of common of the old company back to Frantz's office.
Petitioner's secretary received from the transfer agent 30 certificates, numbered A-5 to A-34, inclusive, each being for 1,000 shares of the new company class A stock, which she delivered to the bank as substitute collateral for the $200,000 note; she brought back to Frantz's office*1037 the released 2,000 preferred and 200 common shares of the old company.
Petitioner, in the meantime, had obtained the 2,900 preferred and 500 common shares of the old company which had been held by Frantz as collateral. He thereupon gave his secretary certificates for all 4,900 shares preferred and 700 shares common of the old company and instructed her to take them down to the transfer agent and to exchange the 4,900 preferred of the old company for 24,500 class A new company stock and the 700 shares of common for 7,000 shares of class A.
Petitioner's secretary obtained from the transfer agent 31,500 shares of class A stock of the new company, which she brought to *462 Frantz's office, and, save for 1,500 shares, they were delivered to Frantz to be held as collateral for petitioner's $100,000 note.
Petitioner then instructed his secretary to go to the transfer agent and get all of the other shares to which he was entitled, being 92,000 class A and 125,000 class B, and to put them in his safety deposit box. This she did.
Neither petitioner's secretary nor the representative of the transfer agent who handled the actual exchange of the old shares for the new shares*1038 appeared as a witness.
After the reorganization was completed there had been issued to petitioner a total of 153,500 class A shares and 125,000 class B shares of the new company, while he had turned in to the new company a total of 4,900 shares of preferred and 6,000 shares of common of the old company.
The other class A shares of the new company, i.e., the 4,000 shares for J. J. Leidecker and the 10,250 shares for the Leidecker Bondholders Protective Committee, were never issued to petitioner.
There was nothing in the records of the transfer agent to show that any particular new shares were issued in exchange for any particular old shares. Instructions to the transfer agent over petitioner's signature, as president of the new company, were as follows:
To Harry M. Runkle or his order 153,500 shares of Class A stock and 125,000 shares of Class B stock on surrender to you of 6,000 shares of International Derrick & Equipment Company common stock and 4,900 shares, par value $100.00 per share, of the preferred stock of The International Derrick & Equipment Company, duly indorsed in blank.
The new company class B shares were of no value when received by petitioner.
In July*1039 1931 petitioner was requested to take up the $750,000 par value of preferred stock of the new company which the Battelle estate had received in exchange for the $750,000 par value of bonds which they had held in the old company. Petitioner agreed to take up these shares and he pledged 50,000 class A stock to guarantee his promise.
In December 1931 Frantz suffered a stroke and, being apprehensive of the future, called in petitioner, his son-in-law, and told him that he thought it would be preferable if he, Frantz, would have some of the stock in his name rather than petitioner's note for $100,000. This was agreeable to petitioner, provided there were no tax complications. It was agreed between petitioner and Frantz that 10,000 shares of class A stock should be transferred to Frantz and the note canceled. Ten certificates, numbered A-35 to A-44, inclusive, for 1,000 shares each were endorsed and delivered to Frantz, who had these shares reissued in his own name.
*463 Since Frantz was surety on petitioner's note for $200,000 held by the Huntington National Bank, he retained the remaining 20,000 shares of class A stock in the new company to protect himself.
In his 1931*1040 tax return petitioner claimed a loss of $100,000 on the sale of 10,000 class A shares to Frantz, claiming $200,000 as the cost basis and allocating the 24,500 class A shares exclusively to the 4,900 shares of preferred stock in the old company, which 4,900 shares had cost him $490,000. The 129,000 of class A (plus the 125,000 shares of class B which had no value) he allocated as being received in exchange for 6,000 shares of old company common, which had cost him $350,000.
The Commissioner in his notice of deficiency disallowed the claimed loss of $100,000 and applied the "first in, first out" rule, with a resulting capital gain of $70,279.10 and a deficiency of $21,243.03. At the hearing respondent abandoned the above theory of determining cost and contended for the "average cost" basis.
OPINION.
VAN FOSSAN: The primary question to be determined is the cost basis of the new company class A stock which petitioner transferred to Frantz on the cancellation of his note for $100,000 held by Frantz. This stock had been acquired in the statutory reorganization whereby the International Derrick & Equipment Co., the old company, merged with the Stacey Engineering Co., forming the*1041 International-Stacey Corporation, the new company.
The Commissioner, in the notice of deficiency, based the deficiency on the application of the "first in, first out" rule. Before the hearing in the present case he changed his ground, and seeks to justify a deficiency by applying the "average cost" rule, he now contending that the basis of gain or loss on stock acquired under a nontaxable reorganization is the total cost of the old shares divided by the total number of new shares.
As authority to substantiate his contention respondent cites ; affd., (C.C.A., 6th Cir.); , affirming memorandum opinion of the Board; ; affd., (C.C.A., 3d Cir.); , affirming memorandum opinion of the Board; ; ; *1042 .
To meet this line of authority petitioner attempts to distinguish the present action by reason of the fact, so he asserts, that the shares transferred to Frantz were actually identified with specific shares given in exchange on the reorganization. We are unable to agree. *464 Despite the elaborate procedure pursued by petitioner in exchanging his stock in the old company for that in the new company, further complicated by petitioner's relationship as a debtor to the bank and to Frantz, we can not find that there was proper identification of shares and consequently believe the rule of the Von Gunten ann other cases to the same effect applies. The farthest we can go on the record is to find that in exchange for 4,900 shares of preferred and 700 shares of common petitioner received 31,500 shares of class A stock.
The rule of the cited cases is based on the concept that, if identification of shares is not definitely established, stock acquired in a reorganization is acquired in a single transaction and for a single consideration. It was said in *1043 , that "there is no practicable way of determining the cost of the shares received in exchange" other than that adopted by the Board in the Von Gunten case. In the Stifel case stock of two corporations acquired at different times was exchanged for stock in the new corporation at varying ratios. Here we have two classes of stock of one corporation exchanged for two classes of stock in the new corporation. Identification of shares exchanged was not sufficiently proved.
There is nothing in the records of the transfer agent to show that any particular old shares were identifiable with particular new shares, and the instructions issued by petitioner as president of the new company contemplated no such procedure. Neither petitioner's secretary nor the representative of the transfer agent, who handled the actual exchanges and might have testified to what actually occurred, appeared as a witness.
We are of the opinion and hold that the correct cost basis for the class A shares sold by petitioner in the taxable year is to be found by dividing the total cost of the old shares, both preferred and common, $840,000, by 153,500, the*1044 total number of new shares of class A stock, it being conceded by respondent that the class B shares had no value when received.
There remains for consideration the question of how much of the gain is to be taxed at capital rates and how much at ordinary rates, the 6,000 common shares having been held by petitioner more than two years and the 4,900 preferred shares less than two years.
There is no specific statutory provision governing the question, nor has the Commissioner promulgated any appropriate regulation. Likewise, there is no decision of the Board in point, the matter being referred to but not ruled on in
The petitioner does not discuss the question in his brief. Respondent, however, suggests that "since under section 113(a)(6) of the Revenue Act of 1928, the basis of the class A shares received on the exchange is the same as the collective basis of the shares exchanged, *465 it follows, under the provisions of section 101(c)(8) of the statute and subparagraph (A) thereunder, that the class A shares sold were in part capital assets and in part non-capital assets." He further suggests that in this situation it is not logical*1045 to tax the gain entirely as capital gain or entirely as ordinary gain and advances as a possible solution the following:
The basis of the old common shares was $350,000.00, and the basis of the old preferred shares was $490,000.00, a total basis for the two classes of shares of $840,000.00. The fraction 350,000/840,000 or 5/12 measures the extent to which the Class A shares are capital assets, and the fraction 490,000/840,000 or 7/12 measures the extent to which the Class A shares are non-capital assets. The profit on the sale should be taxed in the same proportion, 5/12 as capital gain and 7/12 as ordinary income.
The above suggested answer has the merit of simplicity and would seem to be both reasonable and equitable. No better solution occurs to us. It is, therefore, held that the tax, if any be due on the disposition of the 10,000 shares of class A stock, should be computed in accordance with the above formula.
Reviewed by the Board.
Decision will be entered under Rule 50.
Footnotes
1. Sec. 113(a)(6), Revenue Act of 1928. ↩