*1820 As a result of the reorganization of the Curtiss Aeroplane & Motor Corporation the petitioners received in exchange for each share of preferred stock in the original company one-half share of preferred stock in the Curtiss Aeroplane & Motor Co., and one-half of a certificate of beneficial interest in the Curtiss Assets Co. In 1924 the petitioners sold their certificates of beneficial interest in the Curtiss Assets Co. Held, the latter transaction was one in which gain or loss should be determined under section 204(a)(6), Revenue Act of 1924.
*629 In these proceedings, which have been consolidated for hearing and decision, the petitioners seek a redetermination of their income tax liability for the calendar year 1924, for which year the respondent has determined a deficiency as to Glenn H. Curtiss in the amount of $21,645.65, of which only $4,629.30 is in controversy, and as to Lena P. Curtiss, a deficiency in the amount of $1,811.55.
*630 The above mentioned deficiencies*1821 are the result of the respondent's refusal to allow as a loss the amount of $37,034.43 alleged by Glenn H. Curtiss to have been sustained in 1924 on the sale by him of 813 certificates of beneficial interest in the Curtiss Assets Co., and the refusal of the respondent to allow to Lena P. Curtiss a loss in the amount of $20,680, alleged to have been sustained by her in 1924 on the sale of 377 certificates of beneficial interest of the Curtiss Assets Co.
FINDINGS OF FACT.
Glenn H. Curtiss and Lena P. Curtiss were stockholders in the curtiss aeroplane & Motor Corporation, having acquired their stock during the year 1915. On June 30, 1923, the Curtiss Aeroplane & Motor Corporation was reorganized. The plan of this reorganization and the reasons for it, were set out in a circular mailed to all stockholders and dated March 12, 1923, the pertinent portions of which are as follows:
Your Corporation now has the following capital stock outstanding:
Preferred Stock $5,463,100 (par value) - Common Stock 218,016 no par value shares. It likewise has liabilities secured by mortgages on the Company's property:
| U.S. Government First Mortgage (secured by the Buffalo Plant and | |
| by the Corporation's patents) | $552,000.00 |
| U.S. Government Second Mortgage (secured by the Buffalo Plant | |
| and by the Corporation's patents) | 300,000.00 |
| Purchase Money Mortgage on Curtiss Field, Mineola, N.Y | 500,000.00 |
| Mortgage and accrued interest on Garden City Plant, which is | |
| owned by Curtiss Engineering Corporation, the stocks of which | |
| this Corporation has agreed to purchase by contract | |
| dated Sept. 1, 1919, as supplemented | 424,701.16 |
| 1,776,701.16 |
*1822 The Corporation has never declared a dividend on the common stock, and no dividends on the preferred stocks have been paid sonce January 1920.
The Corporation has earned no surplus net profits during 1920, 1921 and 1922 and, therefore, it has not been able to set aside sums either for the payment of preferred dividends, or for the preferred stock sinking fund, because dividends and sinking fund payments may be paid only to the extent that there are surplus net profits available for that purpose, as provided by the certificate of incorporation and the laws of New York.
The Corporation has among its assets certain aeroplanes and motors acquired after the Armistice from the War Department, together with the parts therefor. It also has a commercial inventory represented by planes, motors and parts manufactured by the Corporation for the purpose of sale for commercial use. In accordance with Schedule A hereto annexed these items as of Dec. 31, 1922, at cost price to the Corporation, less depreciation, total $1,659,941.54.
The Corporation likewise owns certain domestic aeroplane patents which in 1917 were subjected, upon the insistence of the Government, to the provisions of*1823 a cross license agreement which is administered by the Manufacturers' *631 Aircraft Association. Under this agreement the Corporation was to receive a maximum of $2,000,000. It has already received $434,580. Commencing with May 1, 1923, and thereafter until 1933, the Corporation will receive from the Manufacturers' Aircraft Association royalties at the rate of $175 for every aeroplane manufactured in the United States until the balance of said $2,000,000 maximum payment has been received.
At the present time sales are being made of the government and commercial inventories from time to time and moneys are received from the Manufacturers' Aircraft Association. The directors feel that these moneys, although they are properly now being used in connection with the Corporation's manufacturing enterprises, are nevertheless in the nature of a realization or liquidation of capital assets, and in view of the fact that preferred dividends have not been earned or paid for the last three years, they should be set aside for the benefit of the preferred stockholders in such a way that whatever is realized from these assets should be turned over to the preferred stockholders.
* * *1824 *
The business of the Corporation is almost wholly manufacturing for the Army and the Navy. This business does not and will not justify the present capitalization of the Corporation. To protect the investment of the preferred stockholders, to enable the Corporation to refund its obligations when due, and assure it of needed working capital, and to afford to the Corporation an opportunity to become a strong manufacturing enterprise by segregating the activities which have nothing to do with its manufacturing functions, the following plan of reorganization has been informally approved by the owners or representatives of owners of a majority in interest of both the preferred and common stock at whose instance the plan is presented to the stockholders.
I. CURTISS ASSETS COMPANY.It is proposed to form a new company bearing the name "Curtiss Assets Company" or some similar name (hereinafter called the Assets Company) under the laws of the State of New York or some other state, having a nominal capitalization of no par value stock. The Assets Company will issue its Certificates of Beneficial Interest of an aggregate par value of $2,731,500, being approximately one-half the par*1825 value of the outstanding preferred stock of the present Corporation. The stock and Certificates are to be delivered to the present Corporation in consideration of the sale to the Assets Company of the present inventory of aeroplanes, motors and spare parts acquired from the Government, as well as certain of the inventory constructed for the purpose of sale for commercial use substantially as set forth in Schedule A hereto annexed, the aggregate cost of which, less depreciation charged off, as set forth in said schedule, is $1,659,941.54.
The present Corporation will also sell to the Assets Company all of said Corporation's rights in all the domestic aeroplane patents owned by it and covered by the above-mentioned cross license agreement with the Manufacturers' Aircraft Association dated July 24, 1917, from which a maximum balance of $1,565,420 may be realized. Thus the present depreciated book value of the inventory and the maximum recovery value of the patents, to be turned over to the Assets Company aggregate $3,225,361.54, for which the Corporation will receive $2,731,500 Certificates of Beneficial Interest and all of the capital stock of the Assets Company.
By contract, *1826 the present Corporation will agree to pay all expenses in connection with the inventory so transferred, such as insurance, upkeep, selling, taxes and overhead charges so that the Assets Company will receive net the *632 full cost price to it (substantially as provided in Schedule A hereto annexed) of each unit if the price received therefor be in excess of cost, in which event the present Corporation will retain the excess over cost of the price received to reimburse itself to such extent for its expenses. If the price received be below cost, then the Assets Company will retain the gross amount received. This contract will run for not less than ten years and will be terminable by the Assets Company upon ninety days' notice at any time.
Inasmuch as the present Corporation's domestic aeroplane patents are included (together with real and other property of said Corporation) in property mortgaged to the United States Government, the transfer of such patents must be subject to that mortgage. Nevertheless the present Corporation will agree to pay off such mortgages to the Government, when due, and thus permit the Assets Company to retain and distribute, entire, after the mortgages*1827 have been paid, the sums received from Manufacturers' Aircraft Association.
From time to time as the directors of the Assets Company may determine, sums of money received from the sales of inventory, and (after 1926) from payments from the Manufacturers' Aircraft Association, will be distributed to the holders of said certificates of beneficial interest. Said Certificates in substance will evidence the right of the holders thereof to receive distributions, as aforesaid, from the net amounts realized by the Assets Company from the liquidation of such inventory and from the patents, up to but not exceeding the par value of such Certificates. Although the patents are subject, as aforesaid, to the Government mortgages, the payment of these mortgages will be assumed by the new Aeroplane Company (provided for in the following paragraph), and that Company will undertake to reimburse the Assets Company for payments or other obligations which the Assets Company may incur on account of said mortgages. Said Certificates will be registered and transferable, so far as possible, in the same manner as stock certificates. Distributions will be made to the holders thereof upon surrender of coupons*1828 annexed thereto or pursuant to some other method of crediting such payments. Upon the final liquidation of the inventory and receipt of all sums payable in respect of the patent rights as aforesaid, a final distribution will be made to the holders of such certificates (or prior to such final liquidation and payments, in case the full par value of such certificates may theretofore be paid) upon surrender thereof. Although there is the prospect of paying the full par value of such certificates out of the moneys realized from the inventory and patents, in case the net amounts so realized are less than such par value, the Assets Company will not be obligated to make up such deficiency. The Assets Company will not engage in any business other than such as may be necessary or incidental to liquidating the said inventory and collecting payments due from the patents.
2. CURTISS AEROPLANE & MOTOR COMPANY.
It is proposed to incorporate a company with the name "Curtiss Aeroplane & Motor Company" or some similar name (hereinafter called the New Aeroplane Company) under the laws of the State of New York or some other state, with a capitalization of $2,731,500 par value (being substantially*1829 one-half the par value of the outstanding preferred stock of the present Corporation) Seven Per Cent Preferred Stock, cumulative as to 5% but non-cumulative as to the remaining 2%, said 2%, however, to be payable out of the net profits in any given year before any dividends are paid on the common stock. The preferred stock shall likewise participate equally, share for share, in dividends paid on the common stock until a total of $42.00 per share over and *633 above preferred dividends have been thus distributed, after which time the holders of preferred stock will no longer be entitled to such participation. This provision is intended to afford the holders of the preferred stock of the present Corporation, on which an aggregate of $21.00 per share of cumulative dividends remains unpaid for the reasons above mentioned, an additional participation equal to such accumulated unpaid dividends.
The New Aeroplane Company shall also have the right to purchase on the open market or by private sale and retire its said preferred stock at not exceeding the current redemption price out of surplus or net profits. It may call said stock for redemption, in whole or in part, on 60 days' *1830 notice, at any time, $100at per share, plus accrued dividend, plus any part of the above mentioned additional participation of $42 per share which has not previously been paid.
The New Aeroplane Company shall likewise issue 218,060 shares (being the number of outstanding shares of common stock of the present Corporation) of no par value common stock.
The present Corporation will sell to the New Aeroplane Company all of its assets of whatsoever nature other than those sold to the Assets Company as enumerated above, and will receive therefor all of the $2,731,500 par value, preferred stock and all of the 218,060 shares of common stock of no par value of the New Aeroplane Company.
The New Aeroplane Company will assume all of the liabilities of the present Corporation, including the payment of the mortgages to the United States Government which are in part secured by the patents proposed to be transferred to the Assets Company as above described and including obligations of the present Corporation under its contract with the Assets Company above mentioned.
3. EXCHANGE OF STOCK.
The preferred stockholders and the holders of voting trust certificates for preferred stock of*1831 the present Corporation shall receive, for each $100 share, $50.00 par value of Certificates of Beneficial Interest of the Assets Company, and $50.00 par value of the Preferred Stock of the New Aeroplane Company upon surrender of their certificates of preferred stock or voting trust certificates for preferred stock of the present Corporation, together with a waiver of their rights to accrued dividends, sinking fund payments and any other rights which they may have in connection with said stock.
The holders of the common stock and the holders of voting trust certificates for common stock of the present Corporation shall, upon surrender thereof, receive no par value common stock of the New Aeroplane Company, share for share.
The above described plan was carried out in the reorganization, substantially as outlined in the circular.
The opening balance sheet of the Curtiss Aeroplane & Motor Co. (the new company) as of July 1, 1923, shows:
| Assets of | $5,086,079.85 |
| Liabilities of | 1,476,016.89 |
| Net | 3,610,062.96 |
| Common stock | 1,086,912.96 |
| Preferred stock | 2,523,150.00 |
| Total common and preferred stock | 3,610,062.96 |
*634 The opening balance sheet of the*1832 new Curtiss Assets Co. as of July 1, 1923, shows:
| Assets of | $2,524,150.00 |
| Less set aside for common stock | 1,000.00 |
| Net asset value of certificates of beneficial | |
| interest of new corporation | 2,523,150.00 |
At the date of the reorganization Glenn H. Curtiss owned 1,626 shares of the preferred stock of the Curtiss Aeroplane & Motor Corporation (old company), which cost him $106,548.85, and Lena P. Curtiss owned 1,752 shares of the preferred stock of said corporation, which cost her $131,366. Glenn H. Curtiss, at the date of reorganization, received for his 1,626 shares of preferred stock in the Curtiss Aeroplane & Motor Corporation 813 shares of preferred stock of the Curtiss Aeroplane & Motor Co. of a par value of $100 per share, and 813 certificates of beneficial interest of the Curtiss Assets Co. of a par value of $100 each. Lena P. Curtiss, at the date of reorganization, for the 1,752 shares of preferred stock of the Curtiss Aeroplane & Motor Corporation, received 876 shares of preferred stock of the Curtiss Aeroplane & Motor Co. of a par value of $100 each, and 876 certificates of beneficial interest of the Curtiss Assets Co. of a par value of $100 each.
*1833 The cost of each of the two new blocks of stock received by the petitioners was set up on the petitioners' books at exactly one-half of the cost of the original stock, so that the cost of Glenn H. Curtiss' 813 shares of preferred stock in the Curtiss Aeroplane & Motor Co. was set up at $53,274.43, and the cost of his 813 certificates of beneficial interest in the Curtiss Assets Co. was set up at $53,274.43. The cost of Lena P. Curtiss' 876 shares of preferred stock in the Curtiss Aeroplane & Motor Co. was set up at $65,683, and the cost of her 876 certificates of beneficial interest in the Curtiss Assets Co. was set at $65,683.
During the year 1924 Glenn H. Curtiss sold 813 certificates of beneficial interest of the Curtiss Assets Co. for $16,240 and Lena P. Curtiss sold 377 certificates of beneficial interest of the Curtiss Assets Co. for $7,540.
The certificates of beneficial interest of the Curtiss Assets Co. were first quoted on the New York Curb Exchange during the week of April 25, 1924, at $20 per certificate, and the preferred stock of the Curtiss Aeroplane & Motor Co. was first quoted on the New York Stock Exchange during the week ending February 15, 1924, at $70 per*1834 share. No part of the shares of the preferred stock of the Curtiss Aeroplane & Motor Co. received upon the reorganization was disposed of by petitioners during the year 1924.
*635 OPINION.
BLACK: It is conceded by all parties to this proceeding that the exchange of securities in 1923, which has been fully explained in our findings of fact, falls within the terms of section 202(c)(2) of the Revenue Act of 1921 and was a transaction in which no gain or loss is recognized.
It is equally clear that the sale in 1924 by petitioners of certificates of beneficial interest in the Curtiss Assets Co. was one in which gain or loss should be recognized and is governed by section 204(a)(6) of the Revenue Act of 1924, the applicable part of which reads:
SEC. 204. (a) The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that -
* * *
(6) If the property was acquired upon an exchange described in subdivision (b), (d), (e), or (f) of section 203, the basis shall be the same as in the case of the property exchanged, decreased in the amount of any money received by the*1835 taxpayer and increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such exchange under the law applicable to the year in which the exchange was made. * * *
It is the contention of petitioners that, because the language of the foregoing section says that where there has been an exchange of securities in a reorganization the new securities received shall take the same basis of cost as the old securities surrendered, therefore each share of preferred stock in the new Curtiss Aeroplane & Motor Co. took the same basis as the cost of one share of preferred stock in the old Curtiss Aeroplane & Motor Corporation and each beneficial interest certificate in the new Curtiss Assets Co. took the same basis as the cost of one share of preferred stock in the old Curtiss Aeroplane & Motor Corporation. In passing upon the merits of that contention, it should be remembered that in the reorganization each holder of a share of preferred stock in the old corporation received for it one-half share in the new Curtiss Aeroplane & Motor Co. and one-half share in the Curtiss Assets Co. The aggregate of these two one-half shares took the same basis of*1836 cost as each share of preferred stock in the old corporation, but in our opinion it could only be held that they each took an equal portion of the cost of the original share of preferred stock in the old company upon a showing being made that the fair market value, at the time of the exchange, of the preferred stock in the new Curtiss Aeroplane & Motor Co. and the certificates of beneficial interest in the Curtiss Assets Co. was the same. In other words, we hold that this transaction is one which requires an apportionment of the basis of cost of each share of preferred stock in the old company surrendered between the one-half share in the *636 Curtiss Aeroplane & Motor Co. and the one-half certificate of beneficial interest in the Curtiss Assets Co. received in exchange therefor. X plus Y may equal 1 but that does not necessarily mean that X equals one-half and Y equals one-half. X may equal three-fourths and Y may equal one-fourth. It can only be held that X equals one-half and Y equals one-half when the evidence shows that fact to be true.
Respondent refused to treat the sale of the certificates of beneficial interest as one in which loss could be recognized, citing*1837 as justification for his action a part of article 1567 of Regulations 62, which he quoted in the deficiency letter as follows:
If property is exchanged for two kinds of property and no gain or loss is recognized under Articles 1564 and 1566, the cost of the original property shall be apportioned, if possible, between the two kinds of property received in exchange for the purpose of determining gain or loss upon subsequent sale, or if no fair apportionment is practicable, no profit on any subsequent sale of any part of the property received in exchange is realized until, out of the proceeds of sale shall have been recovered the entire cost of the original property.
In refusing to treat the sale of the certificates of beneficial interest as one in which gain or loss might be recognized, we think respondent was in error. It was properly held, we think, in I.T. 2335, C.B. VI-1, p. 28, that while Regulations 65 (Revenue Act of 1924) and Regulations 69 (Revenue Act of 1926) do not contain any provisions corresponding to article 1567 of Regulations 62 (Revenue Act of 1921), nevertheless, the provisions of article 1567 of Regulations 62 lay down a principle which is equally applicable*1838 to reorganizations under subsequent acts. We think the applicable part of article 1567 of Regulations 62 to the instant case is as follows:
* * * When securities of a single class are exchanged for new securities of different classes so that no gain or loss is realized under the provisions of paragraph (b) of article 1566 [relating to reorganizations], for the purpose of determining gain or loss on the subsequent sale of any of the new securities the proportion of the original cost, or other basis, to be allocated to each class of new securities is that proportion which the market value of the particular class bears to the market value of all securities received on the date of the exchange. For example, if 100 shares of common stock, par value $100, are exchanged for 50 shares of preferred and 50 shares of common each of $100 par value, and the cost of the old stock was $250 per share, or $25,000, but the market value of the preferred on the date of the exchange was $110 per share, or $5,500 for the 50 shares, and the market value of the common was $440 per share or $22,000 for the 50 shares of common, one-fifth of the original cost, or $5,000, would be regarded as the cost*1839 of the preferred, and four-fifths, or $20,000 as the cost of common. * * *
In applying the above quoted regulation to the facts of the instant case we are confronted with the necessity of finding the respective values of the preferred stock of the new Curtiss Aeroplane & Motor *637 Co., and the certificates of beneficial interest in the Curtiss Assets Co. at the time they were received in the exchange. The two new securities were set up on the books of the respective corporations at par, and if such action could be taken as proof of the value of said securities on that date, then the apportionment of costs should be made on an equal basis, as it was made on petitioner's books, but it can not be so received. Petitioners did not establish that the assets taken over by the respective corporations in the reorganization were worth the amount at which they were set up on the books of the new corporations. If any appraisement was made of the assets at the time of the reorganization by any reputable appraisers, it was not put in evidence. It was stipulated that the certificates of beneficial interest of the Curtiss Assets Co. were first quoted on the New York Curb Exchange during*1840 the week of April 25, 1924, at $20 per certificate and the preferred stock of the Curtiss Aeroplane & Motor Co. was first quoted on the New York Stock Exchange during the week ending February 15, 1924, at $70 per share. If any sales of either security were made prior to the ones above mentioned, no evidence of that fact was offered at the hearing. After a careful review of all the evidence we think the above prices for which they were first sold represents the respective values of the securities at the time the exchange took place. Figured on this basis, the securities which Glenn H. Curtiss received in the reorganization were valued as follows:
| 813 shares preferred stock in Curtiss Aeroplane & Motor | |
| Co., at $70 per share | $56,910. |
| 813 certificates of beneficial interest in Curtiss Assets | |
| Co. at $20 per certificate | 16,240. |
| Total value of all securities received | 73,150. |
, the cost of the 1,626 shares of preferred stock in Curtiss Aeroplane & Motor Corporation (old company) was $106,548.85. The basis of cost of the 813 certificates of beneficial interest in the Curtiss Assets Co. is 16,240/73,150 of $106,548.85, which equals $23,677.52. The loss which petitioner*1841 Glenn H. Curtiss is entitled to deduct from his 1924 income on account of the sale of 813 certificates of beneficial interest in the Curtiss Assets Co. is $7,437.52, instead of the $37,034.43, as claimed by him.
The securities which petitioner Lena P. Curtiss received in the reorganization were valued as follows:
| 876 shares preferred stock in Curtiss Aeroplane & Motor | |
| Co. at $70 per share | $61,320. |
| 876 certificates of beneficial interest in Curtiss Assets | |
| Co. at $20 per certificate | 17,520. |
| Total | 78,840. |
*638 The cost to her of the 1,726 shares of preferred stock of the Curtiss Aeroplane & Motor Corporation (old company) was $131,366. The basis of cost of the 876 certificates of beneficial interest in the Curtiss Assets Co., which she received was 17,520/78,840 of $131,366, which equals $29,192.44, or $33.32 per single certificate of beneficial interest. In the taxable year she sold 377 of these certificates for $7,540. The basis of cost of these 377 shares was $12,561.64 ($33.32 multiplied by 377). The loss which petitioner Lena P. Curtiss is entitled to deduct from her 1924 income on account of the sale of 377 certificates of beneficial interest*1842 in the Curtiss Assets Co. is $5,021.64, instead of the $20,680 claimed by her.
Reviewed by the Board.
Judgment will be entered under Rule 50.
VAN FOSSAN did not participate in the consideration of or decision in this report.