*1136 1. Holders of preferred stock, purchased at par, received socalled dividends which were paid out of capital. Held, such distributions reduced the base cost of their stocks, resulting in taxable gains when the stocks were later sold back to the corporation at par.
2. Preferred stock was acquired as a gift prior to March 1, 1913. The owner received so-called dividends which were paid out of capital. The stock was exchanged for bonds of the same corporation, at par. Held, the base value of the preferred stock had been reduced by distributions of capital assets, resulting in taxable gain when the bonds were later redeemed at par.
*39 These proceedings, which were consolidated for hearing and decision, are for the redetermination of deficiencies in income tax, asserted by the respondent, as follows:
| Petitioner | Docket Nos. | Years | Deficiency |
| DeVer C. Warner | 53743 | 1927 | $919.09 |
| DeVer H. Warner | 53744 | 1928 | 1,750.00 |
| John Field | 53745 | 1927 | 775.93 |
| Ira F. Warner | 53746 | 1928 | 1,407.15 |
| Bradford G. Warner | 53747 | 1927 | 988.42 |
| Margaret W. Field | 60453 | 1929 | 403.61 |
*1137 Numerically, many errors are alleged, but they all resolve into a single issue. That is, whether the cost basis of preferred stock should be reduced by the amounts paid to petitioners by the issuing *40 corporation as dividends, when such amounts were paid out of capital.
FINDINGS OF FACT.
The Warner Brothers Company is a corporation, located at Bridgeport, Connecticut. Originally, and for many years, the principal business of the company was the manufacture and sale of corsets and their accessories.
Prior to the year 1911 the company had issued only common stock, with a par value of $100 per share. In that year it was authorized to, and did issue 5,000 shares of preferred stock, of the par value of $100 per share.
From time to time thereafter, as the business required, the capital stock was increased. On January 1, 1926, its capitalization was 25,000 shares each of common and preferred stock, of a total par value $5,000,000.
The company has never had any funded debt.
In March, 1926, the capital structure was reorganized and 5,000 additional shares of preferred stock were issued for cash at par of $100 per share. There were also authorized 50,000 shares*1138 of common stock of no par value, but of a stated value of $1,250,000. The company's books showed net assets, available for the common stock, to the amount of $2,124,691.96. The change in capitalization was effected by the exchange of two shares of new no-par-value stock for each share of old outstanding common stock. The remaining $1,250,000 of old common stock value was credited to surplus account, which then showed a balance of $874,691.96. There was no distribution of assets to the stockholders.
The preferred stock was all 8 per cent cumulative, with dividends payable quarterly. It was preferred both as to dividends and as to distribution of assets, but it had no voting power.
On March 31, 1926, five of the petitioners, who then held common and preferred stock in the company, subscribed for additional preferred shares as follows:
| Shares | |
| Bradford G. Warner | 500 |
| DeVer H. Warner | 1,000 |
| John Field | 500 |
| Ira F. Warner | 1,000 |
| DeVer C. Warner | 500 |
On October 1, 1927, petitioners Bradford G. Warner, John Field and DeVer C. Warner sold and delivered to the company, at $100 per share, the additional preferred stock purchased in 1926. On January 3, 1928, petitioner*1139 DeVer H. Warner sold to the corporation, *41 at $100 per share, 1,000 shares of preferred stock purchased in 1926; and at the same time Ira F. Warner sold to the company, at $100 per share, 437 of the 1,000 shares purchased in 1926.
Immediately prior to the capital reorganization in 1926 the 25,000 shares of common stock were held as follows: 23,425 shares by members of the Warner family and the estate of Lucien C. Warner, deceased; 575 shares by others who were connected with the company's business; 1,000 shares were treasury stock. Those holdings were doubled after the reorganization and so continued until later than April 1, 1929, except that the holdings of the Lucien C. Warner estate were distributed among his children. A substantial portion of the company's preferred stock was sold from time to time to the public of Bridgeport and vicinity. It was not a listed stock, but was occasionally sold over the counter by local bankers. At the time of reorganization in 1926 the investing public held 4,351 of the 25,000 outstanding shares.
Upon and after the reorganization the amount of capital and surplus applicable to the no-par-value common stock aggregated $2,124,691.96. *1140 This comprised a stated value of $25 per share and a surplus value of $17.49 per share, and constituted the entire net assets of the company over and above $3,000,000, representing the par value of the outstanding 30,000 shares of preferred stock.
The company paid substantial dividends upon its common stock until February 8, 1923, but has paid none since that date.
After the reorganization the company paid 2 per cent dividends quarterly upon its preferred stock. The last two payments in 1926, and all of those in 1927, were made from surplus until it was exhausted, when such dividends were paid out of capital. The deductions from so much of the surplus and capital accounts as belonged to and were part of the capital of the common stockholders were reflected upon the books and records of the company. Such books and records, at all times from and after the reorganization, reflected as a liability the full par value of the outstanding preferred stock. At all times since the financial reorganization of the corporation it has had sufficient net assets with which to pay and discharge in full its obligations to the holders of its preferred stock.
There was no obligation to pay*1141 preferred dividends, except out of profits. They were paid out of capital because a substantial part of the preferred stock was owned in small lots by investors of limited means; and also for the purpose of benefiting the future credit and standing of the company and its common stock.
*42 With respect to the preferred stock issued in March, 1926, petitioners received dividends, up to and including October 1, 1927, in the following aggregate amounts:
| Petitioner | Shares held | Dividends received |
| Bradford G. Warner | 500 | $6,000 |
| John Field | 500 | 6,000 |
| Ira F. Warner | 437 | 6,118 |
| DeVer H. Warner | 1,000 | 7,000 |
| DeVer C. Warner | 500 | 6,000 |
In determining profits realized from sales of the preferred stock back to the company, respondent treated all the above dividends as having been paid out of capital. He therefore reduced the cost bases of the stock by the amounts of those dividends, respectively.
Margaret W. Field did not acquire any of the new issue of preferred stock in 1926, but she was the owner of 100 shares of preferred which she acquired by gift prior to March 1, 1913. On that date that stock was worth at least $100 per share and its redeemable*1142 value was $110 per share. On October 18, 1927, Margaret W. Field exchanged 100 shares of preferred stock for ten bonds of $1,000 each issued by the Warner Realty Company. Those bonds were called in at par on October 31, 1929, but she did not report any profit on their redemption. Respondent treated the exchange of stock for bonds as nontaxable. He took as a basis for the bonds the par value of the preferred stock as being its fair market value on March 1, 1913. The taxpayer had received $4,000 in dividends upon her preferred stock for the years 1923 to 1927, inclusive, and of that amount respondent determined $2,783.36 to be nontaxable because paid out of capital. The latter amount was deducted from $10,000, the March 1, 1913, value of the stock exchanged, leaving $7,216.64 as respondent's determination of the basic value of the bonds received in 1927. As the petitioner received $10,000 for the bonds two years later, respondent determined that she received a taxable profit of $2,783.36 on the transaction.
OPINION.
MARQUETTE: The contention of the petitioners is that the capital assets of the Warner Brothers Company were allocated, part to the common stock and part to the*1143 preferred stock, and that so-called dividends paid out of capital assets to the preferred stockholders were paid from that portion allocated to the common stock. Hence, they say there was no distribution of capital assets applicable to the preferred stock and therefore there should be no deduction from the par value of that stock to determine its basic value for gain or *43 loss purposes. There is no dispute respecting the accuracy of respondent's computations if his premise is correct.
We can not agree with the petitioners. Whatever bookkeeping practice may have been adopted by the Warner Brothers Company, the fact remains that its capital assets constituted a single fund to which creditors and all classes of stockholders alike must look for payment of their claims. We know of no law, and none has been cited to us, by which corporate capital may be allocated among various classes of stock and each allocation made sacred to its assigned stock. Whatever benefit to a corporation and its stockholders may spring from such an allocation, it is simply an accounting device which can not vary or nullify the provisions of the revenue acts. These acts make no distinction. Section*1144 201(d) of the Revenue Act of 1926 is plain. It provides that:
If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not out of earnings or profits, then the amount of distribution shall be applied against and reduce the basis of the stock provided in section 204, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property. * * *
The same language is used in the Revenue Act of 1928, section 115(d).
Petitioners admit that the distributions to preferred stockholders, in the guise of dividends, were not wholly out of earnings or profits, but were in part out of capital. There is no contention that the distributions were in partial or complete liquidation of the Warner Company. It follows that to the extent that such distributions were made out of capital they constituted returns of capital to the petitioners. Respondent has determined that the earnings of the company were exhausted prior to the time when petitioners acquired the preferred stock in question, hence all the so-called*1145 dividends were paid out of capital. No evidence overthrowing that determination was presented.
Petitioners having thus received back a part of their capital through quarterly distributions, the cost basis of their preferred stock was reduced pro tanto, with resulting gain when they resold their stock to the company for par. This applies to petitioner Margaret W. Field as well as to the other petitioners, for after receiving some capital distributions upon her preferred stock she exchanged that stock for bonds which were redeemed by the company at par.
Decision will be entered for the respondent.