*835 1. Where the taxpayer, in June 1933, surrendered to the corporation of which he was a stockholder certain of its stock in consideration of the cancellation of his debt to the corporation, and thereafter, without the knowledge of the taxpayer, there was inserted by the treasurer of the corporation in the minutes of the directors' meeting which authorized the purchase, an option allowing the taxpayer to repurchase the same shares, an act not made known to the taxpayer nor ratified by the directors of the corporation until September, held, that the transaction was not a wash sale within the meaning of section 118, Revenue Act of 1932.
2. Held, that petitioner established the March 1, 1913, value claimed for certain stock received by gift, and no gain resulted on its sale.
*679 This proceeding arises by reason of respondent's determination of a deficiency of $685.25 in petitioner's income tax for the year 1933. Petitioner denies the correctness of the determination and claims a refund of the tax already assessed and*836 paid in the amount of $129.17. Two questions are raised: (1) Whether respondent erred in disallowing a loss deduction of $12,615.69 on the ground that the surrender of stock by petitioner to the company in cancellation of his obligations to the company was in effect a "wash sale" within the meaning of section 118(a) of the Revenue Act of 1932; and (2) whether respondent erred in finding a taxable profit of $7,108 on 200 shares of the same stock acquired by petitioner as a gift and part of the total number of shares so surrendered by him in the taxable year. Two issues are subsumed under this latter head: (1) Whether the March 1, 1913, value of the stock was greater than that at which it was returned, as petitioner now contends; and (2) whether, in the surrender *680 of his 519 shares to the corporation, 200 shares or only 189 shares, as petitioner contends, constituted gift stock. The facts were stipulated in part.
FINDINGS OF FACT.
Petitioner is a resident of Chicago, Illinois, and is the secretary and a director of Gutmann & Co., an Illinois corporation which was incorporated in 1892 to carry on the business of manufacturing leather theretofore conducted by a partnership*837 organized in 1889.
On June 27, 1933, the petitioner was indebted to Gutmann & Co. in the sum of $62,967.06, and on that date paid the indebtedness by transferring to Gutmann & Co. 519 shares of its capital stock and paying the sum of $7.17 in cash. The book value of the stock as of January 1, 1933, was $121.31 a share and the 519 shares were accepted at that value per share in settlement and payment of the indebtedness.
On June 27, 1933, petitioner owned a total of 530 shares of the capital stock of Gutmann & Co., which had been acquired as follows:
15 shares had been purchased from Gutmann & Co. on June 1, 1920 at a purchase price of $2,118.50 per share.
15 shares had been purchased by petitioner from Gutmann & Co. on February 1, 1922, at a price of $1,839.17 per share.
300 shares were issued to petitioner as a 1000 percent stock dividend on the above described 30 shares on December 23, 1922.
200 shares were acquired by petitioner from his father, E. J. Gutmann, by gift.
The 200 shares referred to were acquired under the following circumstances:
At the time of the original organization of Gutmann & Co. in 1892 E. J. Gutmann, one of the founders, acquired 185*838 shares, of which he subsequently sold 25 shares, leaving a balance owned by him of 160 shares. E. J. Gutmann continued to own the same 160 shares and no more until December 23, 1922. On December 20, 1922, the form of the stock certificates issued by Gutmann & Co. was changed and certificate No. 2 in the new form was issued to E. J. Gutmann, evidencing the same original 160 shares of stock. On December 23, 1922, by reason of the 1000 percent stock dividend, there were issued to E. J. Gutmann an additional 1,600 shares of the capital stock of Gutmann & .co., evidenced by certificate No. 14. On December 9, 1925, E. J. Gutmann, desiring to make a gift of 200 shares, caused certificate No. 14 for 1,600 shares to be split into two certificates, viz.: certificate No. 25 for 1,400 shares, which was in the name of E. J. Gutmann, and certificate No. 26 for 200 shares which, pursuant to the direction of E. J. Gutmann, was issued in the name of Daniel N. Gutmann, the petitioner, and was thereupon delivered by E. J. Gutmann to the petitioner as a gift.
On March 1, 1913, there were issued and outstanding (not including 10 shares of authorized but unissued stock held in the company's *681 *839 treasury) 740 shares of capital stock of Gutmann & Co. No rights were issued with respect to the 740 shares thus outstanding on March 1, 1913, nor was any stock dividend paid thereon, nor any capital distribution made with respect thereto until December 23, 1922, when Gutmann & Co. paid a stock dividend of 1000 percent and at that time issued as such stock dividend ten times the number of its shares then issued and outstanding, which in the aggregate was not less than 7,400 shares of its capital stock. There was one increase in capital in 1920, when the authorized stock was increased from 750 to 1,000 shares. This stock was offered to superintendents of the company works and to petitioner, petitioner purchasing 15 shares as set out above. There was no issuance of stock rights.
On June 27, 1933, petitioner delivered to Gutmann & Co. all of the certificates evidencing the total of 530 shares of its stock owned by him at that time and received back certificate No. 39 for 11 shares, dated June 27, 1933.
The petitioner in his income tax return for the year 1933 reported a loss upon the transfer of his 519 shares of capital stock to Gutmann & Co. in payment of his indebtedness, *840 computed by including at a cost of $59,365.05 the 330 shares constituting the 30 shares purchased from Gutmann & Co. in 1920 and 1922, as set forth above, and the 300 shares received as a stock dividend thereon.
The petitioner also included in his return, as a part of the same transaction involving the surrender of the stock, 189 shares out of the 200 shares of stock received by him as a gift from his father. E. J. Gutmann, as set forth above, at $16,210.53, or $85.77 a share, the book value of these shares as of January 1, 1913 (after giving effect to the 1000 percent dividend), and thereon admitted a gain, which was more than offset, however, by the loss claimed above.
The Commissioner disallowed the deduction by petitioner of $12,615.69 as a loss in that year claimed on the 330 shares bought and surrendered by petitioner, and added as additional income $7,108 on the ground that it was taxable profit from the sale of 200 shares received by petitioner as a gift from his father; the Commissioner, unlike the petitioner, treating all of these 200 shares given to petitioner by his father as surrendered to the company on June 27, 1933.
The minutes of the special meeting of the*841 board of directors of Gutmann & Co. held on June 27, 1933, the day of the surrender to the corporation of 519 of petitioner's shares of that company's stock, which minutes were put in evidence under the stipulation and are incorporated here by reference, show that three employees of the company, E. S. Greensfelder, L. H. Elkan, and petitioner, were severally indebted to the company in substantial amounts, petitioner's debt being $62,967.06, which arose, except for a portion of Greensfelder's *682 obligation, from the purchase of the company's stock; that each of them had given valuable service to the corporation, but was unable then to pay his debt; and that they had severally proposed to sell their shares to the corporation. It was accordingly resolved that the offers be accepted and, in the case of petitioner, that the assignment by him of 519 shares and the payment of $7.17 in cash be accepted "in full payment and satisfaction" of his indebtedness set out. It was stated that the surrendered stock would be canceled and held in the treasury of the company under the authority of the "Business Corporation Act" then pendig in the Illinois legislature. There then follows this*842 statement:
The President further stated that, in view of the services rendered, and to be rendered, by them, it was deemed desirable that an option be granted to Messrs. Greensfelder, Gutmann and Elkan, or any of them, expiring not later than July 1, 1938, to purchase all or any part of the respective number of shares of stock of the Corporation conveyed by them, at the book value thereof as of the close of business on the last day of the month preceding the exercise of said option.
Thereupon, on motion duly made and seconded, it was unanimously
RESOLVED, that Messrs. Eugene S. Greensfelder, Daniel N. Gutmann and Leo H. Elkan be, and they are hereby, granted an option to purchase from the Corporation at any time on or before July 1, 1938, all or any part of the shares of stock sold and assigned by them respectively, or any of them, to the Corporation, as of June 27, 1933, upon giving to the Corporation ten days' written notice of their intention so to do, at the book value of said stock as of the close of business on the last day of the month next preceding the date of such notice; that the book value of said stock shall be determined by the Board of Directors, but that in the*843 event of any dispute as to said book value, the same shall be fixed by arbitration by a board of three arbitrators; the proposed purchaser to appoint one arbitrator; the Board of Directors to appoint a second arbitrator, and the two arbitrators so named to appoint a third arbitrator; the decision of the arbitrators to be final and binding; and
BE IT FURTHER RESOLVED, that in the event the Corporation shall, prior to July 1, 1938, sell or otherwise dispose of all, or substantially all, of its assets, or be merged or consolidated with any other corporation or corporations, the aforesaid option herein granted shall expire on the date of such sale, disposition, merger or consolidation.
BE IT FURTHER RESOLVED, that in the event of the exercise of said option, the time and manner of payment for said shares of stock shall be determined by the Board of Directors.
* * *
The signature of petitioner as secretary appears at the end of this resolution.
Petitioner did not know anything of the option resolution until some time late in September 1933, when he signed the minutes. Petitioner did not ask for the option at the time the cancellation was discussed, and has never exercised*844 it. He made delivery of the stock to the corporation on June 27, 1933.
No action was taken by the directors at their meeting on June 27, 1933, in respect to the option, which was incorporated after the *683 treasurer, who ordinarily assisted in preparing the minutes, had taken them to the company's counsel on June 28 with the suggestion that something might be done to soften the harshness of the required surrender of the stock. The minutes of this meeting were not prepared until September 1933. No other meeting of the directors was held to ratify the action shown on the option, but the minutes as prepared were read and approved at the September directors' meeting.
The stock of Gutmann & Co., which was engaged in the tanning business, has always been closely held and within the control of petitioner's family. There were no sales of the stock around March 1, 1913.
The book valuation of the capital stock of the company from 1908 to 1917, inclusive, was as follows:
| Date | Total book net worth | Book value per share as then constituted | Book value per share adjusted to reflect 1000% stock dividend of 12/23/22 |
| Sept. 1, 1908 | $585,965.31 | $791.84 | $71.98 |
| Sept. 1, 1909 | 595,655.92 | 803.59 | 73.05 |
| Sept. 1, 1910 | 568,912.41 | 768.80 | 69.89 |
| Jan. 1, 1912 | 686,186.88 | 927.28 | 84.30 |
| Jan. 1, 1913 | 698,170.64 | 943.47 | 85.77 |
| Jan. 1, 1914 | 749,564.21 | 1,012.94 | 92.08 |
| Jan. 1, 1915 | 790,824.28 | 1,068.68 | 97.15 |
| Jan. 1, 1916 | 822,166.84 | 1,111.04 | 101.00 |
| Jan. 1, 1917 | 988,022.10 | 1,335.17 | 121.38 |
| Jan. 1, 1918 | 1,130,979.10 | 1,528.35 | 138.94 |
*845 The net earnings of Gutmann & Co. before provision for income taxes as shown by the books of that corporation for the fiscal periods from September 1, 1908, to December 31, 1917, were:
| 1908 | $168,299.74 |
| 1909 | 91,462.29 |
| 1910 | 4,284.97 |
| 1911 | 130,193.85 |
| 1912 | 79,981.73 |
| 1913 | $99,318.59 |
| 1914 | 87,932.66 |
| 1915 | 85,094.44 |
| 1916 | 236,251.40 |
| 1917 | 216,957.00 |
The dividends paid on the company's stock for the years 1903 to 1920, inclusive, were as follows:
| Year | Rate | Amount |
| Parcent | ||
| 1903 | 35 | $25,900 |
| 1904 | 50 | 37,000 |
| 1905 | 25 | 18,700 |
| 1906 | 30 | 22,200 |
| 1907 | 50 | 37,000 |
| 1908 | 100 | 74,000 |
| 1909 | 40 | 29,600 |
| 1912 | 80 | 59,200 |
| 1913 | 50 | $37,000 |
| 1914 | 50 | 37,000 |
| 1915 | 60 | 44,400 |
| 1916 | 60 | 44,400 |
| 1917 | 100 | 74,000 |
| 1918 | 60 | 44,400 |
| 1919 | 100 | 74,000 |
| 1920 | 125 | 92,500 |
*684 The book value of the fixed assets of Gutmann & Co., as of March 1, 1913, less depreciation as shown by the books, was $207,715.99.
The fair market value of the fixed assets as of March 1, 1913, was $411,280.21, or $203,564.22 more than the depreciated book values.
The conservative method of accounting used by Gutmann & Co. before March 1, 1913, was not*846 to capitalize certain costs, particularly that of plant labor in the installation of machines; and also to take excessive depreciation upon a reducing balance basis, and even arbitrarily so as to reflect a low book value; with the result that the net earnings as appeared on the company's books were measurably less for the five-year period before the basic date than they otherwise would have been. The company had secret trade processes on March 1, 1913, of a value of $159,039.08, the net worth of its tangibles and intangibles on that date being $1,080,294.21.
The fair market value of the 740 shares of stock of Gutmann & Co. outstanding on March 1, 1913, was then $1,460 per share, and the then fair market value of a share, after reflection of all increases in the capital stock by stock dividend and otherwise until and including December 23, 1922, was not less than $133.
OPINION.
KERN: 1. The first question is whether petitioner is barred from taking a deduction for the loss of $12,615.69 claimed by him on the surrender of his Gutmann & Co. stock on the ground that it is within the prohibition of the "wash sale" provision, section 118 of the Revenue Act of 1932, set out in*847 the margin. 1 The respondent contends in his deficiency notice that the option given to petitioner "was a part of a transaction whereby 519 shares of Gutmann & Co. stock were surrendered in consideration of the cancellation of notes given *685 by you to the company in payment for certain stock." The option appears as part of the minutes of the meeting of the board of directors on June 27, 1933. The uncontradicted testimony of the petitioner, however, shows that he was in complete ignorance of the option as an existing or potential right until late in September 1933, some three months after his surrender of the stock to the company on June 27 of that year; and the testimony of the company's treasurer shows that it was the custom of the company to have its minutes drawn by its counsel; that the idea of an option to be given the surrendering stockholders, as he put it, "to sweeten the pill", occurred to him the day after the meeting, and he suggested it to counsel, who did not draw the minutes in question until September; and the option was thereafter read and approved by the directors as part of the minutes.
*848 The petitioner contends that no contract right between petitioner and the corporation could arise until the board of directors had acted in September; that petitioner had done nothing in the interim to become a party to such a contract; that, there being no written evidence of the option contract made within 30 days either before or after June 27, 1933, it was, even if existent within this period, invalid under the Illinois Statute of Frauds, Smith-Hurd's Illinois Annotated States, ch. 121 1/2, sec. 4; and that the option was unenforceable for lack of consideration.
We are not concerned here with the question of varying a written instrument by parol evidence, since there is no attack on the ultimate validity of the option after it was ratified by the corporation's board of directors and made known to petitioner. Its validity within 30 days after the surrender by petitioner of his stock in consideration of the cancellation of his indebtedness to the corporation is alone to be considered. An analogous question was recently decided by the Court of Appeals for the First Circuit In *849 , where the trustees and directors of a trust association who owned over 50 percent of its stock on March 24, 1933, adopted a resolution to distribute a dividend on June 29, 1933, to shareholders of record on June 22, 1933, subject to the approval of the president, treasurer, and assistant treasurers. The resolution was informally approved by such officers on or about April 25, 1933, but the approval was not recorded on the books or made public or in any manner communicated to any of the shareholders except the trustees. The dividend was distributed on the date specified. The court said:
* * * Here the resolution voted by the trustees, the directors, on March 24, 1933, by its very terms was not a fully declared dividend, for it was made conditional upon the approval of the president, treasurer and assistant treasurers. It is true that on April 25, 1933, and prior to June 16, of that year, the officers of the association described in the resolution met and informally approved *686 the resolution, but their informal approval was not recorded on the books of the corporation (if that would have been helpful) or made public, *850 or communicated to any of the shareholders except the trustees, who in this case stand as the directors of the association. In other words the shareholders other than the director-trustees, had no knowledge of an approval of the resolution. This being so the relation of debtor and creditor, between the association and the shareholders, did not arise before June 16, 1933, and it was within the power of the trustees, so far as this record discloses, to have rescined the resolution of March 24, 1933, at any time before June 29, 1933, when the distribution was made. It necessarily follows that the dividend was not fully and unconditionally declared before June 16, 1933, and was subject to the tax imposed by section 213(a) [of the National Industrial Recovery Act].
The same conclusion must be reached here, that no contract in respect of the option existed between petitioner and the corporation before the option was ratified by the corporation's directors; or, if the option right be treated as a gift, and informal ratification could be assumed, that the gift was not completed until acceptance by the petitioner donee, a necessary requisite.
*851 The statute provides that no deduction shall be allowed where "the taxpayer * * * has entered into a contract or option so to acquire, substantially identical stock or securities." The testimony here is uncontroverted that petitioner had no knowledge of the proposed option until some time in September, more than two months after his surrender of his stock. There is a rational explanation of what was done, and the testimony, unlike that in , is not colored by the circumstances. It would seem obvious therefore that he could not in any sense be said to have "entered into a contract or option" within the proscribed period.
The loss on surrender by petitioner of his shares was obviously a capital loss and deductible as such.
2. We turn now to the second question, the March 1, 1913, value of the 189 shares sold by petitioner on June 27, 1933, which he had received as part of a gift of 200 shares from his father in 1925. in the case of gifts, the donee, of course, must take the donor's basis, sec. 113(a)(2); and, since the donor held these shares, or rather earlier shares of which these were the natural proliferation in the course*852 of corporate growth, on March 1, 1913, the respondent must employ the fair market value on that date as his basis, sec. 113(a)(13). In doing so he has used existing book values as of that date of $85.77 a share, which has resulted in his determination of a gain of $7,108 on their surrender in 1933. The petitioner in his return used the same 1913 book value, but in his petition contends that this was erroneous. He now denies that any gain was realized on the whole transaction of surrender, and contends that the evidence supports a March 1, 1933, value of $133 a share, upon which he founds his claim for a refund of taxes paid in the amount of $129.17. He also contends that the stipulation supports a finding that only *687 189 of the 200 shares received as a gift were surrendered, but it is impossible to tell from the record which shares were surrendered, since the certificates covering all 530 shares were turned over by petitioner to the corporation and one new certificate for 11 shares was received back by him. We must resort to the presumption raised by the Commissioner's "first in, first out" rule, Art. 58, Regulations 77; and, since the gift shares were the last received*853 by the petitioner, we may presume that those sold and surrendered included only 189 of these, and thus hold in his favor. The benefit of the rule, although commonly invoked by the Commissioner, need not on that account be denied to petitioner.
We think the 1913 basis used was too low, and have found that the shares sold were then worth not less than $133 each, or more than the sale price to Gutmann & Co., which was $121.31, and accordingly that no gain was realized on the sale.
We need not elaborate the facts set out in our findings which support this conclusion. Since Gutmann & Co. was a closely held corporation and no sales of its stock took place around March 1, 1913, its stock value must be determined by the then value of its assets, sec. 113(a)(13). Its methods of accounting were very conservative, as two expert witnesses testified and as is shown by an auditor's report drawn February 20, 1923, and put in evidence. Proper adjustments in capital account and depreciation showed that net earnings had been underestimated and the assets thereby undervalued, and, since no proper account had been taken of the value of intangibles, good will, and the trade secrets of tanning*854 employed by the company, the value of these intangibles must be added to the total value of the assets.
Without approving in detail the methods employed by the expert witnesses in arriving at a valuation, we are of the opinion that in all the circumstances the determination of a fair market value on March 1, 1913, of $133 a share for the 189 shares was reasonable and supported by the evidence. We hold, accordingly, that the deficiency be expunged and that the petitioner has made an overpayment.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 118. LOSS FROM WASH SALES OF STOCK OR SECURITIES.
(a) In the case of any loss claimed to have been sustained from any sale or other disposition of shares of stock or securities where it appears that, whithin a period beginning 30 days before the date of such sale or disposition and ending 30 days after such date, the taxpayer has acquired (by purchase or by an exchange upon which the entire amount of gain or loss was recognized by law), or has entered into a contract or option so to acquire, substantially identical stock or securities, then no deduction for the loss shall be allowed under section 23(e)(2); nor shall such deduction be allowed under section 23(f) unless the claim is made by a corporation, a dealer in stocks or securities, and with respect to a transaction made in the ordinary course of its business.
(b) If the amount of stock or securities acquired (or covered by the contract or option to acquire) is less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the loss from the sale or other disposition of which is not deductible shall be determined under rules and regulations prescribed by the Commissioner with the approval of the Secretary.
(c) If the amount of stock or securities acquired (or covered by the contract or option to acquire) is not less than the amount of stock or securities sold or otherwise disposed of, then the particular shares of stock or securities the acquisition of which (or the contract or option to acquire which) resulted in the nondeductibility of the loss shall be determined under rules and regulations prescribed by the Commissioner with the approval of the Secretary. ↩