*1849 Under a plan of reorganization, holders of bonds in a corporation, a party to reorganization, were entitled to exchange such bonds for preferred stock in another corporation, a party to the reorganization, and the right to purchase sufficient additional preferred stock at less than market value to bring the face value of stock received on exchange and on exercise of the right up to the face value of bonds exchanged. Held that no loss resulted on exchange of bonds and exercise of the right by paying additional amount.
*416 This proceeding is for the redetermination of a deficiency in income tax for the calendar year 1925, asserted by the respondent in the amount of $656.20. The only issue arises from the disallowance by the respondent of a deduction claimed as a loss upon the exchange of bonds for stock. All of the facts were stipulated and the case was submitted on the pleadings and agreed stipulation.
FINDINGS OF FACT.
The petitioner is a corporation existing under and by virtue of the National Bank Act, with offices at Champlain, N.Y.
The*1850 petitioner in the year 1921 puchased 10 $1,000 Riordon Pulp & Paper Co., Ltd., 10-year, 6 per cent gold bonds at a cost of $9,575.
On or about November 21, 1921, a protective committee for holders of the 10-year 6 per cent gold bonds of the Riordon Pulp & Paper Co., Ltd., was formed and the petitioner deposited its bonds with this committee. The protective committee consummated a plan of reorganization dated March 2, 1925, a copy of which was admitted in evidence under the stipulation.
Pursuant to the terms of this plan of reorganization, the petitioner, on June 5, 1925, delivered title to its 10 Riordon Pulp & Paper Co., Ltd., 6 per cent gold bonds and, having made a payment of $4,975, received 100 shares of 7 per cent preferred stock of the International Paper Co.
The cost to the petitioner of the 100 shares of International Paper Co. 7 per cent preferred stock received as a result of this transaction, was $14,550, as follows:
| Cost of 10 $1,000 Riordon Pulp & Paper Co., Ltd., 6 per cent gold bonds | $9,575 |
| Cash paid on exercising rights to purchase 70 shares of | |
| International Paper Co. 7 per cent preferred stock | 4,975 |
| 14,550 |
The market value of the*1851 100 shares of International Paper Co. 7 per cent preferred stock acquired by the petitioner in this transaction on June 5, 1925, the date of exchange, was $90.50 per share, or $9,050.
Under the plan approved by the 6 per cent bondholders' committee, and under a corresponding plan which was adopted by the committee constituted under deposit agreement dated September 8, 1921 (as amended March 31, 1924) representing holders of the 8 per cent first mortgage and refunding gold bonds of Riordon Co., Ltd. (hereinafter referred to as the 8 per cent bondholders' committee), it was proposed that all the properties formerly owned by the Riordon Co., Ltd. (which was the successor of the Riordon Pulp & Paper Co., Ltd.), with certain other related properties, be sold to the Canadian *417 International Paper Ltd., a newly formed Canadian company (which would take title directly or through a subsidiary), and that all the capital stock of that company be acquired by the International Paper Co., a New York corporation, engaged in the manufacture of newsprint and other kinds of paper, the development of water power, and sale of hydroelectric power, and other related industries.
The depositors*1852 of the 6 per cent bonds who participated in the plan were to receive, in exchange for their interest in the properties involved, 7 per cent cumulative preferred stock of the International Paper Co., in the amounts and subject to the conditions specified below.
At the foreclosure and liquidation sale of the assets of the Riordon Co., Ltd., in Montreal on September 8, 1924, all the properties of that company were purchased either by the 6 per cent bondholders' committee or by the 8 per cent bondholders' committee. In general, each committee purchased the properties on which its bonds had priority over the other issue.
The property purchased by the 6 per cent bondholders' committee at the Riordon Co. sale, however, was subject to a large amount of indebtedness which was provided for in the reorganization, as more fully specified below.
The properties to be transferred by the two bondholders' committees were to be paid for by the Canadian company in part by the delivery to the committees or their respective depositors of securities of the International Paper Co., and in part by the payment in cash of several millions of indebtedness outstanding against the properties.
To provide*1853 for these requirements and also for additional working capital, the International Paper Co. was to authorize an issue of 6 per cent sinking fund mortgage gold bonds and an issue of new 7 per cent preferred stock. In connection with its acquisition of the securities of the Canadian company, the International Paper Co. was also to issue an additional $5,000,000 par value of common stock.
The new bonds were to bew secured by direct pledge of all the capital stock of the Canadian company, which was to own, either directly or through its own subsidiaries, the Canadian properties of the Riordon Co. acquired from the two committees, and certain other Canadian properties then held by a subsidiary of the International Paper Co. They were also to be secured by a mortgage and pledge, junior to the lien of the present first and refunding mortgage bonds of the International Paper Co., of all the pulp and paper mills directly owned by the International Paper Co. at the time of the execution of the mortgage and of the stock of certain of its American subsidiaries. *418 About $6,900,000 of the new bonds were to be acquired by the Canadian company and delivered in part payment for the*1854 properties of the 8 per cent bondholders' committee, and it was expected that about $15,500,000 would be sold for cash to provide for the cash payments to be made by the Canadian company in connection with the acquisition of the properties of the two committees and for other corporate purposes of the International Paper Co.
The new 7 per cent preferred stock was to rank in priority to the existing 6 per cent preferred stock of the International Paper Co., but the holders of the 6 per cent stock were given the privilege of exchanging their holdings for the new 7 per cent preferred, share for share, on payment of $10 per share. It was to be of $100 par value, entitled to 7 per cent cumulative dividends, and to par and accrued dividends in liquidation in preference over the existing 6 per cent preferred and the common stock, and redeemable at 115 and accrued dividends, and was to have full voting power equally with the other two classes of stock. Dividends were to be payable quarterly on January, April, July, and October 15th.
The properties of the 6 per cent bondholders' committee were subject to a variety of charges and obligations, aggregating over $6,000,000. Based on figures*1855 of November 30, 1924, the classification and approximate amounts of these liabilities were as follows:
| 1. Mortgage indebtedness: | ||
| First Mortgage Debentures of the Riordon Pulp & | ||
| Paper Company, Ltd., (after payment of sinking | ||
| fund arrears) | $1,562,900.00 | |
| Less Cash and investments in hands of Trustee | 64,809.96 | |
| 1,498,090.04 | ||
| Small real estate mortgages | 86,000.00 | |
| $1,584,090.04 | ||
| 2. Rentals and title retention claims | 37,330.00 | |
| 3. Sinking fund arrears on First Mortgage | ||
| Debentures | 265,900.00 | |
| 4. Advances by Royal Trust Company, Trustee, | ||
| guaranteed by Committee, to pay interest on | ||
| First Mortgage Debentures, with interest on | ||
| such advances, and accrued interest on | ||
| Debentures to November 30 | 407,831.42 | |
| 5. Miscellaneous secured claims | 53,144.29 | |
| 6. Obligations of Committee for indebtedness | ||
| incurred to discharge various prior claims | ||
| against the properties and to pay for | ||
| properties purchased, for interest and | ||
| otherfinancing charges, and for | ||
| expenses of Committee | 1,579,836.05 | |
| 7. Current operating loans, secured against | ||
| inventories and receivables | 1,895,037.09 | |
| 8. Miscellaneous current accounts and accruals | 282,342.17 | |
| 6,105,511.06 |
*1856 *419 The properties were to be transferred subject to the indebtedness included in items 1 and 2 of the above summary, and the miscellaneous current accounts and accruals were to be assumed by the Canadian company. The other items, aggregating (as of November 30, 1924) about $4,200,000 had to be provided for in cash. Of this amount, the committee was required to furnish, as one of the conditions of its agreement with the Canadian company, somewhat less than $2,000,000, and the balance was to be paid by the purchasing company.
In consideration of the transfer of the properties, and of the delivery to the Canadian company of all the 6 per cent general mortgage bonds of the Riordon Pulp & Paper Co., Ltd., held by the committee in behalf of depositors participating in the plan of reorganization, the Canadian company was to (a) transfer to the committee or on its order 10 shares of the new 7 per cent preferred stock of the International Paper Co. for each $1,000 bond so delivered (and in the same proportion for $500 bonds) subject to the committee's providing $500 in cash for each 10 shares so transferred, to be applied in reduction of the obligations against the properties; *1857 and (b) pay or assume the entire remaining indebtedness against the properties.
Each depositor was entitled, on complying with the conditions of the plan, to receive, for each $1,000 bond represented by his certificate of deposit, new 7 per cent preferred stock of the International Paper Co. as follows:
| Shares | |
| Without any cash payment | 3 |
| On Payment of $500 in cash an additional | 7 |
| Total | 10 |
The $500 in cash was payable in installments, 50 per cent on or before May 15, 1925, and 50 per cent on or before July 15, 1925. Interest at 6 per cent per annum to July 15 was to be allowed on the first installment and credited against the final payment.
Of the 10 shares to be received on account of each $1,000 bond participating, 3 shares were to be delivered on or about May 20, 1925, and were to be entitled to dividends accruing from April 15, and the remaining 7 shares were to be delivered on or about July 20, 1925, and were to be entitled to dividends accruing from July 15.
The procedure for participation in the plan was that upon receipt of notice from the committee that the warrants hereinafter mentioned were ready for delivery, each depositor would be entitled*1858 to present his certificate of deposit to the State Street Trust Co., of Boston, depositary, or its agent, the Royal Trust Co. in Montreal, on or before May 15, 1925, and to have stamped thereon a statement of *420 his right to receive on or about May 20, 1925, on surrender of such certificate of deposit, 3 shares of the new 7 per cent preferred stock of the International Paper Co. (if, as and when received by the depositary from the Canadian company) for each $1,000 bond represented by such certificate of deposit. There was also to be issued to each depositor so presenting his certificate of deposit a negotiable warrant entitling the holder thereof to receive on or about July 20, 1925, (if, as and when received by the depositary) seven additional shares of said stock for each $1,000 bond represented by the certificate of deposit against which such warrant was issued, on payment to the depositary, for each seven shares, of $500 in cash (in United States funds) in the installments and on the dates specified above, and subject to credit for interest on the first installment as above stated.
Depositors who did not present their certificates of deposit to be stamped within the*1859 time above specified were, nevertheless, to be entitled, on later surrender of their certificates of deposit, to receive three shares of stock for each $1,000 bond, entitled to dividends accruing from the last previous dividend payment date, but were to forfeit all rights in respect to the other seven shares.
Holders of the above described warrants who failed to make the first installment payment when due were to forfeit all rights under such warrants.
OPINION.
MATTHEWS: This case arises under the Revenue Act of 1926. The respondent contends that under section 203(b)2, no gain or loss is recognized on the exchange of bonds for preferred stock. The petitioner contends that the provisions of the act applicable to the situation are sections 202(c), 202(d), and 203(b)1. The provisions relied on by petitioner and respondent, and other pertinent portions of sections 202 and 203, read as follows:
SEC. 202. (a) Except as hereinafter provided in this section, the gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in subdivision (a) or (b) of section 204, and the loss shall be the excess of such basis*1860 over the amount realized.
* * *
(c) The amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received.
(d) In the case of a sale or exchange, the extent to which the gain or loss determined under this section shall be recognized for the purposes of this title, shall be determined under the provisions of section 203.
* * *
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.
*421 (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 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*1861 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.
* * *
(f) If an exchange would be within the provisions of paragraph (1), (2), (3), of (4) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.
* * *
(h) As used in this section and sections 201 and 204 -
(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*1862 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 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.
* * *
If subdivision (b)(1) of section 203 stood alone, there would seem to be no question that it would control in this case and that the exception therein contained with respect to stocks, bonds, notes, etc., an exception upon which petitioner relies, would take the present case out of the category in which no gain or loss shall be recognized and allow the computation of gain or loss in accordance with section 202. But paragraph 2 of section 203(b) and the subsequent subdivisions of section 203, are intended to cover exchanges in*1863 the various cases of corporate reorganization which may arise, and they must, therefore, be considered, inasmuch as the plan is referred to in the stipulation as a plan of reorganization, and in the plan itself, the transaction is referred to as a reorganization.
It must be determined, however, whether as a matter of law what was accomplished was a reorganization within the meaning of section *422 203(h)(1), and if so, whether the Riordon Pulp & Paper Co. and the International Paper Co. are parties to a reorganization within the meaning of section 203(b)(2), and whether the exchange is one in which the loss can not be recognized.
The plan, which is set forth in our findings of fact, provides in effect for the acquisition by the International Paper Co. of all the properties formerly owned by the Riordon Pulp & Paper Co. and its successor, the Riordon Co., held by the two bondholders' committees, in exchange for its 7 per cent preferred stock and 6 per cent bonds, title to the properties to be taken and held in the name of a Canadian corporation, which was organized for that purpose, all of whose stock was to be owned by the International Paper Co. This is the acquisition*1864 by one corporation of all of the properties of another corporation, and comes squarely within the language used in section 203(h) 1: "The term 'reorganization' means (A) a merger or consolidation (including the acquisition by one corporation of * * * substantially all the properties of another corporation) * * *."
We are not advised as to the date or manner in which the Riordon Co., Ltd., became the successor of the Riordon Pulp & Paper Co., Ltd. We do not think this is material, however, as the plan discloses that all the property which secured the 6 per cent gold bonds of the Riordon Pulp & Paper Co., Ltd., as well as the first mortgage debentures of the Riordon Pulp & Paper Co., Ltd., was purchased by the 6 per cent bondholders' committee at the foreclosure and liquidation sale of the assets of the Riordon Co., Ltd. We conclude, therefore, that the Riordon Co., Ltd., had, at the time it became successor of the Riordon Pulp & Paper Co., Ltd., acquired all the properties of the Riordon Pulp & Paper Co., Ltd., and assumed the bonds which were secured on such properties, and that it was not able to meet either its own obligations on the 8 per cent first mortgage and refunding gold*1865 bonds of the Riordon Co., Ltd., or the obligations on the bonds of the Riordon Pulp & Paper Co., Ltd., which it had assumed. Each bondholders' committee, therefore, purchased the properties on which its bonds had priority over the other issue, and thus the 6 per cent bondholders' committee acquired the property formerly owned by the Riordon Pulp & Paper Co., Ltd. Under the plan adopted by the 6 per cent bondholders' committee, securities of the Riordon Pulp & Paper Co., Ltd., and the properties formerly owned by that company are dealt with, while under the plan adopted by the 8 per cent bondholders' committee, the securities of the Riordon Co., Ltd., and the property of that company which secured such bonds are dealt with. Both plans form a part of the general reorganization plan, but we are concerned with the plan adopted by the 6 per cent bondholders of the Riordon Pulp & Paper Co., Ltd.
*423 We do not think that the intervention of the Canadian corporation to hold title to the properties is material, but even if we considered that there were two simultaneous transactions, the acquisition of the properties of the Riordon Pulp & Paper Co. by the Canadian corporation, *1866 and the acquisition of all the stock of the Canadian corporation by the International Paper Co., it would still be a reorganization, because both transactions fall within (A), which also includes cases where one corporation acquires all the stock of another corporation. This then was a reorganization within the meaning of the statute.
We have next to determine whether the Riordon Pulp & Paper Co., whose bonds were exchanged, and the International Paper Co. whose preferred stock was received in exchange, are parties to the reorganization. The term "a party to a reorganization" is defined in section 203(h)(2).
We are of the opinion that the Riordon Pulp & Paper Co. whose bonds petitioner exchanged, is a party to the reorganization. Any other interpretation would stultify the statute. The fact that the properties of the company had been sold under foreclosure before the plan became effective, does not alter the fundamental fact that it is being reorganized and that its assets and liabilities and its security-holders are being dealt with under the reorganization plan. In this case, the bondholders, upon foreclosure, had become the owners of all the assets of the corporation, *1867 subject to the remaining liabilities, and there was no equity left in the stockholders. The bondholders, therefore, were the only ones who could enter into a plan of reorganization of the corporation.
It will be observed tat paragraph (2) of subdivision (h) of section 203, does not, like paragraph (1), which defines the term "reorganization," employ the word "means," but says that the term "a party to the reorganization includes," thereby merely extending the definition to certain other corporations than the one reorganized. The Canadian corporation is a corporation "resulting from a reorganization" and comes specifically within the terms of the statute. Both the Canadian corporation and the International Paper Co., whose securities were issued in exchange, fall within the second half of the definition which provides that the term "includes both corporations in the case of 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," since here the International Paper Co. acquired all of the capital stock of the Canadian corporation.
The Riordon*1868 Pulp & Paper Co. and the International Paper Co. are, therefore, corporations which are parties to a reorganization.
*424 Does the statute prohibit the recognition of loss in this case?
It is not an uncommon practice, in corporate reorganizations, to give in exchange securities in the new corporation, different in nature and interest rate from those held in the old corporation.
The language of the statute is sufficiently broad to cover an exchange of bonds in a corporation, a party to a reorganization, solely for stock in another corporation, a party to the reorganization, in pursuance of the plan of reorganization. Section 203(b) 2. The only question that need detain us, therefore, is whether loss is to be recognized upon an exchange where additional cash is furnished by the old securityholders in order to receive stock or securities equal in face value to securities exchanged.
Under the instant plan, the old bondholder, in order to realize by the exchange an amount of new stock equal in face value to that of his old bonds, was required to pay in cash an amount equal to 50 per cent of the face value of his old bonds. Such provisions are common in corporate reorganization*1869 plans, since the new corporation usually finds it necessary to provide new money to carry out the plan, but they more ordinarily affect participating stockholders than bondholders. Tracy on Corporate Receiverships, Foreclosues & Reorganizations (1929). Here the stockholders of the old corporation had no equity in the properties and did not participate in the plan. The petitione, as a dpositor, could have surrendered its bonds without any cash payment, but if it had done so, it would have received only three shares of stock having an aggregate face value of only $300 for each $1,000 bond, while by paying $500 in cash additional, it could obtain ten shares of stock of an aggregate face value of $1,000. The right to obtain seven additional shares of stock by paying in $500 in cash, was one reserved to bondholders of the old corporation, who participated in the plan. This right was evidenced by a negotiable warrant issued to each depositor upon presenting his certificate of deposit, entitling the holder thereof to receive on or about July 20, 1925, seven additional shares of preferred stock for each $1,000 bond represented by the certificate of deposit against which such warrant was*1870 issued, on payment to the depositary of $500 in cash for each seven shares. The warrant evidencing such right is property. What each bondholder received upon the exchange of his bonds, therefore, was stock and property.
Under the provisions of subdivision (f) of section 203, no loss is to be recognized in such a case. Cf. ; affirmed in .
Reviewed by the Board.
Judgment will be entered under Rule 50.