*235 Petitioners' decedent in the taxable year 1948 sold certain stock purchase warrants acquired in 1947 from the Follansbee Steel Corporation of which he was the president. At the time of the acquisition of the warrants they had a fair market value in excess of the price paid therefor and the warrants were immediately negotiable.
Held:
1. The warrants were capital assets as defined by section 117 (a) (1), I. R. C.
2. The decedent's base for determining gain or loss on the sale of such stock warrants in the taxable year 1948 is the amount paid therefor, increased by the amount included as additional compensation in the year he purchased the warrants.
*873 This proceeding*236 involves a deficiency in income tax of petitioners' decedent and decedent's wife for the period January 1, 1948, to October 8, 1948, in the amount of $ 30,271.73.
The sole issue is whether petitioners' decedent, Lauson Stone, realized taxable income by way of additional compensation in 1948 as a result of a sale in that year of stock purchase warrants of the Follansbee Steel Corporation.
Many of the facts have been stipulated and are found accordingly. Other facts are found from the evidence.
FINDINGS OF FACT.
Lauson Stone was a resident of the borough of Beaver, Beaver County, Pennsylvania, and until his death on October 8, 1948, he filed his Federal income tax returns with the collector of internal revenue for the twenty-third district of Pennsylvania.
The petitioners, Beaver Trust Company and Helen Darby Stone, are coexecutors of the estate of Lauson Stone, deceased. The petitioner, Helen D. Stone, is the surviving wife of Lauson Stone, and is the same person as Helen Darby Stone, a coexecutor.
Lauson Stone was elected president and director of Follansbee Steel Corporation on October 26, 1942, and thereafter served in both of those capacities until his death. On March 31, 1944, *237 Lauson Stone and Follansbee Steel Corporation, hereinafter referred to as the "corporation," entered into a 5-year employment contract running from January 1, 1943, to January 1, 1948.
During the term of the aforementioned contract, and more particularly at the annual stockholders' meeting of the corporation held on March 27, 1947, a stockholder proposed a resolution to authorize the corporation to issue and sell stock purchase warrants of the corporation to Lauson Stone subject to certain terms and conditions. The resolution was duly adopted. On March 28, 1947, the board of directors of the corporation approved the recommendation of the stockholders.
On May 1, 1947, pursuant to the aforesaid resolution of the stockholders and the directors, 100 warrant certificates, each certificate evidencing the right to purchase 100 shares of the stock of the corporation, were issued and sold to Lauson Stone for the sum of $ 1,000. Each certificate contained the same terms and conditions and differed from each other only in certificate numbers. The warrant certificates *874 were exercisable by Lauson Stone, or assigns, and stated in part: "The corporation shall treat as the absolute owner*238 hereof, for all purposes whatsoever, the person in whose name this Warrant is issued, or, when duly endorsed in blank, the bearer hereof and the Corporation shall not be affected by any notice to the contrary." There were no restrictions on the time or manner in which the warrants could be negotiated. Each certificate provided that the purchase rights represented by the warrant were exercisable as an entirety for the shares purchasable thereunder. The price at which the warrants could be exercised was $ 21 per share. The warrants were dated May 1, 1947, and were exercisable at any time after October 31, 1947, and before May 1, 1952. The average market price of the common stock of the corporation on the New York Stock Exchange on May 1, 1947, was $ 19.75 per share.
The holder of the warrant was fully protected against dilution of his right to purchase stock by reason of an increase in the number of shares outstanding resulting from a stock dividend, a reduction in the par value of the shares, or the issuance of additional shares for cash, property, or services.
The high and low market prices of the stock of the corporation on the New York Stock Exchange during each calendar month*239 of the year 1947 were as follows:
| High | Low | |
| January | 18 | 14 1/2 |
| February | 19 1/4 | 17 |
| March | 23 | 16 1/2 |
| April | 22 1/4 | 17 3/8 |
| May | 20 1/8 | 15 1/8 |
| June | 19 1/2 | 17 3/4 |
| July | 25 1/4 | 18 5/8 |
| August | 27 3/8 | 22 7/8 |
| September | 28 1/2 | 25 1/4 |
| October | 33 3/4 | 27 3/4 |
| November | 33 3/4 | 30 3/4 |
| December | 40 5/8 | 30 |
The high and low for the years 1946, 1947, and 1948 were as follows:
| Year | High | Low |
| 1946 | 21 1/4 | 11 1/4 |
| 1947 | 40 5/8 | 14 1/2 |
| 1948 | 40 1/2 | 22 7/8 |
The high and low for the period June 24, 1948, through June 30, 1948, were 32 1/2 and 30.
In his 1947 income tax return Lauson Stone reported the difference between the value he placed on the warrants, to wit, $ 6,000, and the $ 1,000 he paid for them, or $ 5,000, as additional compensation for the year 1947 from the corporation.
*875 Lauson Stone retained such warrants from May 1, 1947, to June 24, 1948. Between June 24, 1948, and June 30, 1948, he sold 89 of such warrant certificates, representing the right to purchase 8,900 shares of stock of the corporation.
Subsequent to June 30, 1948, Lauson Stone returned 11 warrant certificates representing the right to purchase 1,100 shares of such stock to the corporation, and the latter refunded*240 to him $ 110, the amount he had originally paid therefor. Such 11 warrant certificates were returned because they could not be disposed of by reason of certain prohibitions imposed by the Securities and Exchange Commission.
In the individual income tax return filed for the taxable period January 1, 1948, to October 8, 1948, inclusive, the petitioners reported the sum of $ 82,680.50 1 as having been derived from the sale of the 89 warrant certificates.
The cost of the warrants was reported as $ 5,890 and the difference, or $ 76,790.50, was treated as a long term capital gain. In his deficiency notice the respondent determined that the sum of $ 81,790.50, or the difference between the sale price of $ 82,680.50, and the cost of $ 890, was taxable income as additional compensation.
The corporation in its income tax return for the year 1947 deducted as compensation paid to Lauson Stone, in addition to the salary paid to him under his employment contract, the sum of $ 5,000, computed*241 by subtracting from the sum of $ 6,000 the fair market value assigned to the warrants by Lauson Stone and the $ 1,000 he paid the corporation for such warrants.
In its return for the taxable year 1948 the corporation deducted for compensation paid to Lauson Stone an amount representing the total of (1) the salary paid to him in that year under his employment contract, and (2) in respect to the exercise of said warrants by the purchaser sold, as aforesaid, a sum at least equal to the gross sum reported in the joint return of Lauson Stone and Helen D. Stone, filed for the period January 1, 1948, to October 8, 1948, as having been derived from the sale of the aforesaid warrants.
The fair market value on May 1, 1947, of the warrant certificates purchased by the decedent was at least equal to the amount returned by the decedent as additional compensation in the year the warrants were issued, plus the amount paid for the certificates.
The sale of the warrant certificates by Lauson Stone in the taxable year 1948 was a capital transaction.
The decedent's base for determining gain or loss on the sale of such stock warrants in the taxable year is the amount he paid therefor, increased by the*242 amount returned as additional compensation in the year he purchased such warrants.
*876 OPINION.
The question presented is whether the net consideration received by petitioners' decedent, Lauson Stone, on the sale in 1948 of certain stock warrants is taxable as additional compensation or as capital gain.
The petitioners' decedent was first employed as president and chief executive officer of the Follansbee Steel Corporation on October 26, 1942. On March 31, 1944, the decedent entered into a written contract of employment with such corporation for a period of 5 years from January 1, 1943, which provided that his compensation was not to be less than $ 50,000 per year. From January 1, 1943, until his death he was the president and a director of such corporation. Pursuant to a resolution adopted by its stockholders and the directors, the corporation was authorized to issue and sell to the decedent at a price of $ 10 per warrant 100 negotiable stock purchase warrants for the purchase of 100 shares each of the common stock of the corporation at $ 21 per share. The warrants were dated May 1, 1947, and were to expire 5 years from date unless the period was extended. They were not*243 exercisable for a period of 6 months from their date. There was no restriction upon the sale or transfer of the warrants.
Between June 24 and June 30, 1948, the decedent sold and transferred 89 of the warrant certificates representing the right to purchase 8,900 shares of the common stock of the corporation for the sum of $ 82,680.50.
The respondent, relying upon I. T. 3795, 1946-1 C. B. 15, contends that the stock purchase warrants had no market value when received in 1947, and that the net consideration received on their sale by the decedent in the taxable year 1948 was taxable in full as additional compensation paid to the decedent in that year.
The petitioners contend that the decedent purchased the stock purchase warrants in 1947 in a bona fide transaction; that the warrants were "property" and "capital assets," as defined in section 117 (a) (1) of the Internal Revenue Code; and that on the sale in 1948 the decedent realized a long term capital gain. The petitioners argue that the facts here presented are governed by Treasury Regulations 111, section 29.22 (a)-1, as amended by T. D. 5507, 1946-1 C. B. 18. *244 2*245 The petitioners, relying on T. D. 5507, argue that the amount received by the decedent in the nature of additional compensation is the difference *877 between the amount he paid for the stock warrants and their fair market value on the date of their delivery to him. They further contend that the decedent's base for determining gain on the subsequent sale in the taxable year 1948 is the amount he paid for them, increased by the difference between such amount and their fair market value when the warrants were received. The petitioners further contend that I. T. 3795, supra, 3 is inapplicable and, if intended to cover all stock options, is invalid and not in accordance with the law.
The respondent urges that the parties employed the form of a sale in a vain tax avoidance attempt to qualify the transaction under T. D. 5507, and no bona fide sale was intended. It is also argued that, if the warrants were sold to the decedent for a consideration less than their fair market value, the corporation is placed in the illegal position of having given away its assets. We find no evidence in the record to support*246 an inference that the transaction was not entered into in good faith, and since the issuance and sale of the warrants were authorized by the stockholders the transaction was not ultra vires the corporation.
The stock purchase warrants here involved differ widely from the usual stock purchase options given by employers to officers and employees which have been the subject of consideration by the courts over a long period of years. Since we regard the controlling issue as presenting a factual situation, a discussion of such prior cases will not be helpful.
In applying T. D. 5507, one of the questions to be determined is whether in making the agreement in question the additional compensation was to be the spread between the fair market value of the warrants when issued and the sale price to the decedent, or the spread between the acquisition price and the fair market value of the stock when the options were exercised. In our opinion the reasonable inference to be drawn from the facts presented is that the parties were dealing in stock warrants and not the shares of stock that could be acquired thereunder. The following facts lend support*247 to such view, i. e., the decedent paid a valuable consideration for their issuance; the warrants were negotiable from their date; they were protected against dilution in value; and they were not contingent upon his continued employment.
*878 The courts have recognized that in certain circumstances stock purchase warrants are property. Helvering v. San Joaquin Fruit & Investment Co., 297 U.S. 496">297 U.S. 496; Smith v. Commissioner, 324 U.S. 695">324 U.S. 695. In the Smith case the Supreme Court intimated that the option itself might be found to be the only intended compensation. Of course, the option itself could only be treated as the intended compensation, where the option purchased had a fair market value at the time of its issuance in excess of the price paid therefor. The burden of establishing such facts rested upon the petitioners. They have endeavored to meet such burden through the testimony of two competent and well-qualified stock brokers, and on this record we think that burden has been met.
We are convinced from all the evidence contained in the record that the stock warrants in question on the date of their delivery*248 to the decedent had a fair market value at least of the $ 6,000 placed thereon by the decedent and used as his base in fixing the amount of the additional compensation received in 1947 as a result of the issuance and sale to him of such warrants. It is unnecessary in order to dispose of the issue before us to determine the actual fair market value of the warrants on the date of their delivery, since the petitioners' pleadings do not put in issue the question of any greater value than the amount returned in 1947.
The respondent further contends that the additional compensation which the corporation intended to be paid was the consideration received upon the sale of the warrants by the decedent in 1948, and such an intention is evidenced by the fact that the corporation in its income tax return for 1948 claimed a deduction of the amount the decedent received in 1948, as provided in I. T. 3795, supra. While in certain circumstances the action taken by the corporation might be a factor to be considered in determining the intent of the parties, we do not think it is controlling. We need not determine whether such action on the part of the corporation was proper since that issue *249 is not before us. The mere stipulated fact that the corporation claimed such a deduction, under the facts here presented, is of no material significance on the issue involved.
We do not agree with the respondent's contention that I. T. 3795 is controlling under the facts here presented. Nor do we think that it was intended to cover stock warrants acquired by purchase, the fair market value of which on the date of delivery was in excess of the amount paid therefor.
We have found as a fact that the sale of the stock warrants in the taxable year was a capital transaction, and the decedent's base is that provided in T. D. 5507, supra (footnote 2), and we have so found.
*879 The stock warrants having been held for more than 6 months, the gain from the sale is a long term capital gain. The petitioners in the income tax return filed on behalf of the decedent for the taxable period 1948, in determining the long term capital gain resulting from the sale of the tax warrants, have used a base determined as provided in T. D. 5507.
We hold that petitioners have properly reported the taxable capital gain*250 realized by the decedent from the sale of the stock warrants in the taxable year 1948.
Decision of no deficiency will be entered.
Footnotes
1. The stipulated amount is $ 82,680.↩
2. T. D. 5507, here pertinent, provides as follows:
If property is transferred by an employer to an employee for an amount less than its fair market value, regardless of whether the transfer is in the form of a sale or exchange, the difference between the amount paid for the property and the amount of its fair market value is in the nature of compensation and shall be included in the gross income of the employee. In computing the gain or loss from the subsequent sale of such property its basis shall be the amount paid for the property, increased by the amount of such difference included in gross income.↩
3. That part of I. T. 3795 material here provides:
* * * if an employee receives an option on or after February 26, 1945, to purchase stock of the employer corporation, * * * the employee realizes taxable income by way of compensation on the date upon which he receives the stock to the extent of the difference between the fair market value of the stock when it is received and the price paid therefor.
If the employee transfers such option for consideration in an arm's length transaction, the employee realizes taxable income by way of compensation on the date he receives such consideration to the extent of the value of such consideration.↩