*2106 Where, subsequent to December 31, 1920, property is transferred to a corporation by an individual in exchange for more than 80 per cent, but less than 100 per cent, of the corporation's capital stock, and under section 203(b)(4) of the Revenue Act of 1924 no gain or loss is recognizable on account of such exchange, section 204(a)(8) of the Revenue Act of 1924 requires that the basis, in determining gain or loss on account of the sale of such property by the corporation, shall be the same as it would be in the hands of the transferor, and such requirement is not violative of the Constitution because all of the property owned by the corporation was not received from the controlling interest in such corporation.
*528 This proceeding involves deficiencies in income tax as determined by the Commissioner for 1924 and 1925 in the respective amounts of $1,685.06 and $4,160. The issue presented is whether in determining *529 the profit on the sale of certain securities the cost thereof to the petitioner's*2107 transferor should be used as a starting point. The facts were stipulated.
FINDINGS OF FACT.
On March 19, 1924, Fannie K. Haas was the owner of the following securities, which had a cost basis to her, for income tax purposes, as follows:
| 1268 Shares of common stock of Midway Gas Co | $53,890 |
| 1595 shares of common stock of Southern California Gas Co | 23,925 |
| 5000 shares of stock of Associated Oil Co | 82,000 |
| 1000 shares of second preferred stock of San Joaquin Light & Power Corporation | 70,000 |
| $100,000 par value of San Francisco, Oakland & San Jose Consolidated Railway Co. 5% bonds (known and referred to as "Key Route Bonds") | 25,000 |
On March 19, 1924, The Haas Building Company was a California corporation with its principal place of business at San Francisco, where it was engaged in the business of owning and operating real estate. On said date and also on April 8, 1924, the fair market value of the assets of said corporation, after deduction of all its liabilities, was at least the sum of $200,000. During the months of March and April, 1924, the total issued and outstanding capital stock of said corporation amounted to 3,000 shares of the par value of $100*2108 per share, and said 3,000 shares of stock were at all times from March 1, 1924, to and including April 30, 1924 (at which latter date said corporation was duly dissolved in accordance with law), beneficially owned in equal shares by Walter A. Haas, Ruth H. Lilienthal and Eleanor H. Koshland. The said 3,000 shares of stock were acquired in equal amounts by said Walter A. Haas, Ruth H. Lilienthal and Eleanor H. Koshland in the year 1919 and continuously held by them in such equal amounts until April 30, 1924. The cost basis, for income tax purposes, to said Walter A. Haas, Ruth H. Lilienthal and Eleanor H. Koshland of said 3,000 shares of stock, was at least the sum of $200,000.
On March 18, 1924, the petitioner, namely, The Haas Building Company, Inc., was organized under the laws of California, with an authorized capital of $2,000,000, divided into 20,000 shares, of the par value of $100 each. Said corporation was organized for the purpose of engaging in the business of owning and operating real estate and owning various securities and continued so to engage in business after its organization down to and including December 31, 1925.
On March 19, 1924, The Haas Building Company*2109 offered to transfer to petitioner all of its assets, subject to certain stipulated liabilities, *530 in exchange for the issuance by petitioner to The Haas Building Company of 2,000 shares of the capital stock of the petitioner and the assumption by the petitioner of the aforementioned stipulated liabilities. Said offer was accepted by petitioner on the last mentioned date. On April 8, 1924, the assets of The Haas Building Company were transferred and delivered to petitioner and petitioner issued and delivered to The Haas Building Company 2,000 shares of its capital stock, and assumed said liabilities. The cost basis to The Haas Building Company, for income tax purposes, of the assets transferred by said corporation to petitioner, was at least the sum of $250,000.
On March 19, 1924, Fannie K. Haas offered to sell and transfer to petitioner the following described securities at the prices respectively set opposite said securities:
| 1268 shares of common stock of Midway Gas Co | $253,600 |
| 1595 shares of common stock of Southern California Gas Co | 199,375 |
| 5000 shares of Associated Oil Co | 155,000 |
| 1000 shares of second preferred stock of San Joaquin Light & Power Corporation | 95,000 |
| $100,000 par value "Key Route Bonds" | 70,000 |
| Total | 772,975 |
*2110 The consideration for the sale and transfer of the foregoing securities to the petitioner was the issuance to Fannie K. Haas of 10,000 shares of the capital stock of petitioner, said sale to be made as of March 19, 1924. The offer was accepted by petitioner on March 19, 1924. On April 8, 1924, said Fannie K. Haas transferred and delivered to petitioner said securities hereinabove enumerated and petitioner issued and delivered to Fannie K. Haas 10,000 shares of its capital stock. The fair market value of each of said securities hereinabove listed was, on March 19, 1924, the sum respectively hereinabove set opposite said securities.
On April 30, 1924, upon the dissolution of The Haas Building Company, said Walter A. Haas, Ruth H. Lilienthal and Eleanor H. Koshland received in equal shares from The Haas Building Company the beneficial interest in said 2,000 shares of the capital stock of petitioner. At all times from April 8, 1924, down to and including December 31, 1925, the issued and outstanding shares of stock of petitioner were 12,000 and said 12,000 shares were held and owned as hereinabove shown.
On April 8, 1924, petitioner, in opening its books of account, set up*2111 the securities transferred to it at the market prices shown above as at March 19, 1924.
Shortly subsequent to April 8, 1924, but prior to August 12, 1924, petitioner, in connection with a reorganization of San Francisco, *531 Oakland & San Jose Consolidated Railway Company, received 602 shares of prior preferred stock and 602 shares of preferred stock of Key System Transit Company in exchange for the above mentioned $100,000 par value of bonds of San Francisco, Oakland & San Jose Consolidated Railway Company. Immediately after said reorganization, the fair market value of said 602 shares of prior preferred stock was $48,358.66 and the fair market value of said 602 shares of preferred stock was $21,510.50. On August 12, 1924, petitioner sold said 602 shares of preferred stock of Key System Transit Company for the sum of $21,510.50.
On January 10, 1925, in connection with a reorganization, petitioner exchanged the above mentioned 1,000 shares of second preferred stock of San Joaquin Light & Power Corporation for 455.8 shares of preferred stock of Western Power Corporation and cash in the sum of $47,578, and on the same date purchased two-tenths of a share of preferred*2112 stock of Western Power Corporation for the sum of $17.50. On March 5, 1925, petitioner purchased 39 shares of preferred stock of Western Power Corporation for the sum of $3,412.50. During the month of October, 1925, petitioner sold the said 495 shares of preferred stock of Western Power Corporation for the net sum of $48,135.10.
The aforementioned Walter A. Haas, Ruth H. Lilienthal, and Eleanor H. Koshland are children of said Fannie K. Haas, and on March 19, 1924, each of said children was over the age of 21 years.
Neither The Haas Building Company nor Fannie K. Haas reported any gain or loss, for income tax purposes, for the calendar year 1924, in connection with the transfers by them to petitioner of the property and securities referred to above. And, likewise, Walter A. Haas, Ruth H. Lilienthal and Eleanor H. Koshland did not report any gain or loss, for income tax purposes, for the calendar year 1924, in connection with the receipt by them of the shares of stock of petitioner referred to above.
In determining the profit on the sale of 602 shares of Key System Transit Company preferred stock, the Commissioner proceeded in the following manner:
| Cost to Fannie K. Haas of the bond ($100,000 par value) of the San Francisco, Oakland & San Jose Company which was exchanged on April 8, 1924, for 602 shares of prior preferred stock and 602 shares of preferred stock of the Key System Transit Company | $25,000.00 |
| Market Value of 602 shares of prior preferred stock of Key System Transit Company on April 8, 1924 | 48,358.66 |
| Market value of 602 shares of preferred stock of Key System Transit Company on April 8, 1924 | 21,510.50 |
| Total market value of the above stock on April 8, 1924 ($48,358.66 plus $21,510.50) | 69,869.16 |
| Allocated cost to transferor (Fannie K. Haas) of 602 shares of preferred stock of Key System Transit Company - (21,510.50/69,869.16 X $25,000) | $7,696.70 |
| Sales price on August 12, 1924, of 602 shares of preferred stock ofKey System Transit Company | 21,510.50 |
| Profit on sale | 13,813.80 |
*2113 The profit from the sale of 495 shares of preferred stock of the Western Power Corporation was determined by the Commissioner in the following manner:
| Cost to Fannie K. Haas of 1,000 shares of second preferred stock of San Joaquin Light & Power Company which were exchanged for 455.8 shares of preferred stock of Western Power Corporation and cash in the amount of $47,578 | 1 $65,000.00 |
| Cost to petitioner of 39.2 additional shares of preferred stock of Western Power Corporation | 3,430.00 |
| Total | 68,430.00 |
| Amount received in sale of 495 shares of preferred stock of Western Power Corporation in October, 1925 ($48,135.10), plus cash received at date of exchange ($47,578) | 95,713.10 |
| Profit on the sale | 27,283.10 |
*532 OPINION.
SEAWELL: The parties are agreed that the sole issue for disposition is whether, in determining the profit from the sale by petitioner of certain securities in 1924 and 1925, the basis or*2114 starting point should be the cost of such securities to Fannie K. Haas, the party by whom these securities (or those for which they were exchanged) were transferred to petitioner, or whether it should be their cost to petitioner. As indicated by the foregoing statement and by our findings, we are here concerned only with property received by petitioner from Fannie K. Haas in a transaction by which Fannie K. Haas transferred certain assets to petitioner in exchange for more than 80 per cent of petitioner's capital stock. As to this transaction the parties are agreed (and we think properly so) that section 203(b)(4) of the Revenue Act of 1924 is applicable and prevents a recognition of gain or loss to Fannie K. Haas for income tax purposes on account of such exchange. No gain or loss was reported by Fannie K. Haas with respect to the transaction; the Commissioner made the determination with which we are concerned on the basis of the applicability of section 203(b)(4) to the aforementioned transaction; and in its brief the petitioner made the following statement:
*533 At the outset, it must be conceded by petitioner that Fannie K. Haas transferred to it certain property in*2115 exchange for stock of petitioner and that immediately after the exchange, Fannie K. Haas was in control of petitioner, within the definition and purview of subdivision (b)(4) and subdivision (i) of Section 203 of the Revenue Acts of 1924 and 1926. It must further be conceded that since the property acquired by petitioner from Fannie K. Haas was acquired after December 31, 1930, that Section 204, subdivision (a)(8) of the Revenue Acts of 1924 and 1926 purports to fix as the cost basis of such property to petitioner, the same basis that such property had to Fannie K. Haas, the transferor.
The issue then presented is the basis or starting point to petitioner in determining gain or loss on account of the sale of property which was received under conditions where section 203(b)(4) is applicable. Section 204(a)(8) of the Revenue Acts of 1924 and 1926 provides as follows:
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 -
* * *
(8) If the property (other than stock or securities in a corporation a party to a reorganization) was acquired after*2116 December 31, 1920, by a corporation by the issuance of its stock or securities in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 (including, also, cases where part of the consideration for the transfer of such property to the corporation was property or money in addition to such stock or securities), then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made.
The foregoing section provides in unmistakable terms that where the sale of such property is involved the "basis shall be the same as it would be in the hands of the transferor," with certain adjustments not here material. The contention of the petitioner, however, is that the transferor basis should not here be applied for the reason that in so doing the rights of third parties are adversely affected in a manner which is violative of the Constitution. That is, it is contended in effect that when the petitioner is required to pay a tax on the profit derived from the sale of property*2117 received from Fannie K. Haas and when such profit is determined as the difference between the cost of such property to Fannie K. Haas and its selling price by petitioner, the stockholders of petitioner, who were not interested as owners of such property prior to the exchange, are indirectly being required to contribute to the payment of a tax on a profit, a part of which accrued to Fannie K. Haas prior to the exchange. In a sense this may be true, but we fail to see wherein such considerations would necessarily mean that a tax determined *534 upon such basis is inequitable, arbitrary, or confiscatory. Of course, in any case where we are concerned with a transaction by which the transferor received less than 100 per cent, but at least 80 per cent, of the total outstanding stock of the transferee corporation, the rights of third parties may be affected by the application of section 203(b)(4) and section 204(a)(8), but whether such effect is adverse, or even if adverse, whether it amounts to confiscation or is to be considered arbitrary in the sense that it would require the conclusion that the statute is unconstitutional, are entirely different questions. It is true that the*2118 stock received by the minority interest in this case was not in the exact proportion in relation to the value of assets transferred as that of the party who received the controlling interest, but apparently the minority interest voluntarily carried out its part of the transaction and that with a full knowledge of the stock being issued to the majority interest. Well may there have been other considerations which induced the minority interest to consider the transaction fair and advantageous from its standpoint and which would offset the possible detriment to accrue to it on account of the additional tax here complained of when the transferor basis is used with respect to property received from the controlling interest. And even where stock is issued to the minority interest on the same terms as to the controlling interest, a similar objection might be raised on the ground that a proportionately greater amount of profit might have accrued with respect to one class of property than the other. The use of the transferor basis as set out in section 204(a)(8) has heretofore been upheld as not in violation of the Constitution. *2119 (certiorari denied, ), and . In both of the above cases it was pointed out that it was within the power of Congress to prescribe the use of the transferor basis where no tax was imposed on the profit resulting from the exchange by which the property was transferred to the corporation. While the question of the effect of a minority interest was apparently not raised, for reasons heretofore stated, we are of the opinion that this does not change the situation. Not only does the transferee corporation take the assets for which it exchanges its stock, subject to the burden of the income tax which might properly be assessed in the ultimate disposition of such assets, but also the minority interest may be said to have exchanged its assets for stock subject to the same condition with respect to any profit or losses which might be recognized on behalf of the transferee corporation. Cf. also *2120 , and .
On the whole, we are satisfied that the use of the transferor basis with respect to the property with which we here are concerned is *535 required by section 204(a)(8) and we see nothing in the use of such basis, even where a minority interest is involved, which can necessarily be considered as arbitrary or confiscatory in the sense that it is violative of the Constitution. The Commissioner's action in using the transferor basis is accordingly approved, though the deficiency for 1925 should be recomputed, since in the deficiency notice the cost to Fannie K. Haas of 1,000 shares of second preferred stock of San Joaquin Light & Power Corporation stock was fixed at $65,000 whereas in the stipulation such cost is shown as $70,000
Reviewed by the Board.
Judgment will be entered under Rule 50.
Footnotes
1. While the Commissioner used a cost to Fannie K. Haas of $65,000 for the 1,000 shares of second preferred stock of San Joaquin Light & Power Corporation, the parties have stipulated (as shown above) that the correct cost to her was $70,000. ↩