*2155 Held that the petitioner is entitled to the deduction taken in his income tax return for 1925 for a loss on corporate stock that became worthless during the taxable year.
*164 This proceeding is for the redetermination of a deficiency in income tax of $1,700.99 for 1925. The only matter in controversy is the correctness of the respondent's action in disallowing as a *165 deduction the amount of $9,500 taken by the petitioner as a loss sustained on corporate stock that became worthless during the taxable year.
FINDINGS OF FACT.
The petitioner is a stockbroker and has been so engaged since 1900. In 1923 he paid $4,500 for 50 shares of the preferred capital stock, of a par value of $100 per share, of the Depollier Watch Company, and received as a bonus 50 shares of the common stock of no par value of the same company. In 1924 the petitioner paid $5,000 for 50 shares of the first preferred capital stock of a par value of $100 per share of the same company and received as a bonus 100 shares of the common stock of the company.
The foregoing*2156 shares of stock were acquired by the petitioner by subscription. Only the common stock had voting rights.
The Depollier Watch Company, a Delaware corporation, was incorporated on March 29, 1922. It was organized to engage in the business of manufacturing watches with a patented movement. Shortly after its organization it entered into a licensing agreement with Joseph Burn and Charles F. Depollier whereby it acquired the sole and exclusive right to manufacture watch movements under a certain patent. The agreement was acquired at no cost to the company other than the royalty provided in the agreement of 25 cents to be paid for each watch movement sold. The license agreement was set up on the company's books at a valuation of $250,000. On the basis of this valuation there was set up at the same amount common stock which was issued as a bonus with the preferred stock.
As time progressed, it was known that the license agreement had very little value. From the beginning the company steadily operated at a loss and at January 31, 1924, had a deficit of $39,046.07. At the stockholders' meetings, hopeful views were expressed as to the company making various kinds of contracts, *2157 but it met with great opposition from other manufacturers. Out of a belief that it would do a large volume of business during the Christmas season of 1924, the company prepared a large stock of merchandise. Very little of the anticipated business materialized. Operations for the fiscal year ended January 31, 1925, resulted in a loss of $85,258.38. The deficit at the close of the calendar year 1925 had increased to $212,790.82. The total outstanding capital stock of the company at January 31, 1925, was $174,900 preferred and $250,000 common.
The company became so greatly in need of money that it could not now carry on any longer without obtaining additional loans. About March, 1925, the company pledged its accounts receivable with a commercial credit company for a loan at a very high rate of interest. *166 It was having difficulty in continuing its loans at the bank which had been financing it theretofore and with which a large part of its inventory was pledged. Shortly thereafter the bank refused to make any other loans to the company. In the spring of 1925 an endeavor was made to get a meeting of the stockholders in order to obtain additional financial assistance*2158 in some way. The attorney for the company who was also a stockholder, director and creditor and who had attended all meetings of the officers of the company since its organization, personally went to each of the large stockholders, explained the situation to them and informed them that it was thought that if sufficient finances could be raised the company would be saved. The stockholders refused to do anything and it was decided to sell the assets for what could be obtained for them.
The Dudley Watch Company of Wilmington made an offer to purchase the inventory, and the patent rights and license. The purchase price offered was so small that it was refused. By June, 1925, royalties amounting to about $1,400 had accrued. These royalties were never paid and some time early in 1926 notice of the cancellation of the license agreement was given the company. About June 30, 1925, the fair value of the company's assets was about $80,000, and the liabilities were $60,000 or more in excess of the assets.
Between June, 1925, and December of the same year the financial condition of the company became worse. By the fall of 1925 the company was hopelessly insolvent. At the end of 1925*2159 the general financial condition of the company was such that it was doing no business other than the liquidating of its inventories. The liquidating value of the inventories and the value of the other assets were less than the amount due to creditors. On one group of loans a judgment was obtained against the company for $50,000 and receivers in liquidation were appointed. Loans to the company amounting to $40,000 were never paid. Upon liquidation of the company's assets nothing was available for distribution to the stockholders. The company has never been dissolved.
The stock of the company was not listed on any exchange, it was never traded in by the public, and by the end of 1925 it could not be sold at any price.
In the latter part of 1925 there were discussions among some of the stockholders of the company about incorporating a new company to carry on the business formerly carried on by the Depollier Watch Company. It was thought that by starting out afresh and being rid of the obligations of the Depollier Watch Company, hereinafter referred to as the old corporation, the business could be made successful. A suggested plan of reorganization was mailed to each of the*2160 old company's 25 stockholders. Thereafter and early in *167 March, 1926, a new corporation, known as the Trinity Watch Corporation, was formed under the laws of New York. Afterwards and during the same month the name of the corporation was changed to Depollier Watch Corporation, hereinafter referred to as the new corporation. Ten or eleven of the stockholders in the old corporation, including the petitioner, purchased shares of stock in the new corporation. In 1926 the petitioner purchased 25 shares of the new company's preferred stock of no par value for $2,250 and 95 shares of its common stock of no par value for $250. Both classes of stock had voting rights. There was no exchange of stock in the old corporation for stock in the new corporation nor was the petitioner required to surrender his stock certificates in the old corporation. The common stock in the new corporation was issued at varying prices per share in order to induce some of the stockholders in the old corporation to buy stock in the new corporation.
The new corporation purchased the furniture and certain other assets of the old corporation for cash in the amount of $1,200. The old corporation had*2161 a large inventory and a large amount of accounts receivable which were not taken over by the new corporation. The premises formerly occupied by the old corporation were occupied by the new corporation, but under a new lease. In May, 1926, the new corporation acquired from the owners, and at no cost in excess of the royalties payable thereunder, a license agreement to manufacture watch movements under the same patent that the old corporation had manufactured under. This agreement was similar to the one which the old corporation formerly had but which had been canceled. The new agreement, like the old, provided for a royalty of 25 cents for each watch movement sold.
In his income tax return for 1925 the petitioner took a deduction of $9,500 as representing a loss on account of his stock in the Depollier Watch Company having become worthless in 1925. The respondent has disallowed the deduction taken by the petitioner.
The stock of the Depollier Watch Company became worthless in 1925.
OPINION.
TRAMMELL: The single issue to be determined in this proceeding is whether the petitioner is entitled to deduct under the provisions of section 214(a)(5) of the Revenue Act of 1926, *2162 which is applicable to 1925, the amount of $9,500 as a loss sustained in the taxable year.
The respondent contends that the petitioner is not entitled to the deduction (1) for the reason that the new corporation was a reorganization of the old corporation and consequently no deductible *168 loss is recognized by the reorganization provisions of the statute, and (2) for the reason that the stock of the petitioner in the old corporation did not become worthless during the taxable year. The petitioner contends that the new corporation was not a reorganization of the old and that there is nothing in the reorganization provisions which prevents the loss from being deductible.
With respect to the deductibility of losses resulting from reorganizations, the Revenue Act of 1926 provides in part as follows:
SEC. 203. (a) Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section.
(b) (1) No gain or loss shall be recognized if property held for productive use in trade or business or for investment (not including stock in trade or other property held primarily*2163 for sale, nor stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest) is exchanged solely for property of a like kind to be held either for productive use in trade or business or for investment, or if common stock in a corporation is exchanged solely for common stock in the same corporation, or if preferred stock in a corporation is exchanged solely for preferred stock in the same corporation.
(2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
(3) No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
(4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation, and immediately after*2164 the exchange such person or persons are in control of the corporation; but in the case of an exchange by two or more persons this paragraph shall apply only if the amount of the stock and securities received by each is substantially in proportion to his interest in the property prior to the exchange.
* * *
(h) As used in this section * * *
(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.
(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*2165 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.
*169 (i) As used in this section the term "control" means the ownership of at least 80 per centum of the voting stock and at least 80 per centum of the total number of shares of all other classes of stock of the corporation.
Conceding, for the sake of argument, contrary to what appears to be true, that the new corporation was a reorganization of the old, section 203 provides what classes of losses shall not be recognized. Examining the above quoted provisions of the section, we find that it is certain losses resulting from exchanges that are not to be recognized. In the instant case there was no exchange of any kind involved. The petitioner bought and paid cash for the stock he owned in the old corporation and acquired his stock in the new corporation in the same manner. The petitioner was not required to surrender the stock he held in the old corporation but continues to own it. The evidence shows that the new corporation purchased and paid cash in the amount of $1,200 for the furniture and certain other assets*2166 of the old corporation. There is nothing in the record to indicate that this was not the full value of such assets. There is nothing in the record to indicate any exchange of stock, securities or other property between the two corporations or between the petitioner and either or both of them. Some of the stockholders in the new corporation were permitted to acquire its common stock at a lower price per share than the other stockholders. The reason for this was to induce them to put money into the new corporation had not because some interest that they had in the old corporation had been transferred to the new. We think the first of the reasons advanced by the respondent in support of his contention is without support in the statute. Cf. , and .
The respondent contends that the stock of the old corporation did not become worthless in 1925, while the petitioner contends that it did. In support of his contention the respondent relies on the fact that the old corporation was still carrying the license agreement on its books at approximately $250,000 at January 31, 1926. *2167 He argues that if the agreement had this value then the deficit of the corporation at that date was less than the amount of the common stock, therefore the value of the preferred stock was unimpaired since the corporation had assets of a greater value than the par value of its preferred stock. The license agreement was obtained by the old corporation without any cost other than the payment of the royalties provided therein. Although it was set up on the old corporation's books at a value of $250,000, the evidence clearly shows that with the passage of time it became apparent that it had very little if any value. Each year's operations under the agreement resulted in an increased deficit to the old corporation until in *170 1925 further loans could not be obtained. In our opinion the license agreement in 1925 had little if any value in excess of the royalties payable thereunder. The license agreement contained a forfeiture clause providing for its cancellation by the licensors if the payment of royalties became more than 90 days in arrears. Since in June, 1925, the old corporation owed royalties amounting to about $1,400 which were never paid, it is apparent that at the*2168 end of 1925 the old corporation did not even have the right to call the license agreement its own.
The old corporation appears to have been able to continue operations with some hope of success until the early part of 1925 when it was no longer able to obtain financial assistance. By the fall of 1925 it was hopelessly insolvent and by the end of the year it was doing no business other than liquidating its inventories, which in any event were not sufficient to pay the debts. Therefore, there was nothing for the stockholders. From a consideration of all of the evidence, we are of the opinion that the stock became worthless in 1925 and have so found as a fact. The petitioner is accordingly entitled to the deduction taken. See ; ; ; .
Judgment will be entered under Rule 50.