*24 Decision will be entered under Rule 50.
Deduction for legal expenses in connection with amendment of a corporation's charter, retiring its outstanding capital stock, issuance of new stock in reduced amount, and distribution of assets in partial liquidation, allowed in part and disallowed in part.
*910 The Commissioner determined a deficiency for the calendar year 1946 of $ 693.50 in income tax and $ 13,472.20 in personal holding company surtax. The question is whether the legal expenses entailed in amending a corporation's charter, reducing its authorized and outstanding capital stock, distributing part*25 of its assets, and issuing new stock, are deductible as an ordinary and necessary business expense. The parties submitted a stipulation of facts with annexed exhibits; in addition, petitioner took the testimony of one witness and respondent introduced one exhibit into evidence.
FINDINGS OF FACT.
The facts stipulated are so found.
Petitioner is a closely held corporation organized and operating under the laws of the State of New York, and has its principal office in *911 New York City. It filed its tax returns for the calendar year 1946 with the collector of internal revenue for the second district of New York. It reported its income and kept its records on the cash receipts and disbursements basis.
Petitioner was incorporated in 1916 or 1917. It was formed for two primary purposes: (1) to acquire and hold as an investment all the capital stock of Mills Estate, Incorporated, a California corporation; and (2) to acquire and operate certain improved real estate in New York City (referred to herein as the "real estate"). Its certificate of incorporation authorized it to engage in other business activities as well, and conferred perpetual duration upon petitioner.
The capital*26 stock of petitioner was fixed, by the certificate of incorporation, at $ 5,000,000, consisting of 50,000 shares of a par value of $ 100. The entire authorized stock was issued some time prior to 1943 and remained outstanding immediately prior to 1943.
On or about January 23, 1917, petitioner acquired the New York real estate and the capital stock of Mills Estate, Incorporated. Of a total of the latter corporation's 30,000 shares authorized and issued, petitioner owned 29,995 shares from 1917 to 1946, inclusive, and the few remaining shares were held by individuals to qualify them as directors.
The real estate was sold by petitioner for $ 3,625,000 on or about March 25, 1941. After this sale, petitioner became a personal holding company, subject to the surtax imposed on such companies.
Thereafter several alternatives were considered in connection with disposition of the proceeds of the sale. One of these was complete liquidation of petitioner. This course was rejected in favor of a partial liquidation, which was advised by petitioner's attorneys. It was their view and that of petitioner's directors that the benefit to petitioner of a partial liquidation would extend beyond the*27 time at which the liquidation was made. The result of the sale of the real estate, followed by distribution of the proceeds of the sale, would be withdrawal by petitioner from one of the primary activities for which it was formed.
On November 1, 1943, there was adopted at a meeting of the stockholders of petitioner a resolution instructing the directors of the corporation, first, to file with the state authorities a certificate "reducing the amount of the capital stock of the corporation from $ 5,000,000 to $ 2,800,000, and reducing the number of shares of the corporation from 50,000 shares of the par value of $ 100 each to 28,000 shares of the par value of $ 100 each." Secondly, the directors were instructed "to distribute or cause to be distributed in partial liquidation of the corporation and the return to the stockholders of their capital investment, $ 3,630,000 of the corporation's capital funds, $ 2,200,000 thereof to be charged to the corporation's capital stock and $ 1,430,000 to be charged *912 to its surplus contributed by stockholders, such distribution to be a pro rata distribution in cash to stockholders of record at a date to be fixed by the directors upon the *28 basis of $ 165 per share for the 22,000 shares so cancelled and retired." The resolution stated that this distribution was "in consideration of such reduction and the cancellation and retirement of 22,000 shares of the corporation's capital stock."
On the same date there was adopted at a meeting of petitioner's board of directors a resolution directing Anderson, Gasser, Ferris & Anderson, petitioner's attorneys, to file with the state authorities the "certificate of reduction of capital stock and number of shares" which had been executed on or about October 26, 1943, by the holders of record of all the outstanding shares of the corporation. The directors' resolution also authorized and directed corporate officers to pay to the stockholders of record on November 5, 1943, upon surrender of a stated proportion of the holdings of each of them and a total of 22,000 shares, "in partial liquidation of the corporation and as a return to stockholders of their capital investment, for each share of such previously authorized stock so assigned and transferred to the corporation $ 165, $ 100 thereof to be charged to the corporation's previously authorized capital stock and $ 65 thereof to be charged*29 to the corporation's surplus contributed by stockholders." The directors' resolution further provided that the surrendered certificates be cancelled and the shares retired which they represented, and that upon transfer to the corporation of the remaining 28,000 shares of capital stock, there was to be issued in exchange therefor "certificates for 28,000 shares of the then authorized capital stock of the corporation of the par value of $ 100 each and aggregating $ 2,800,000."
Pursuant to this resolution, the certificate of reduction of capital stock and number of shares was filed with the secretary of state on or about November 1, 1943, and a copy was filed with the county clerk on or about November 8, 1943. Thereafter, in 1943, petitioner distributed pro rata to its stockholders $ 165 per share, aggregating $ 3,630,000. Petitioner's stockholders surrendered certificates of stock for 50,000 shares: 22,000 of these shares, surrendered in respect of the foregoing distribution of assets, were cancelled and retired; for the rest of the surrendered stock, 28,000 shares of new stock were issued.
Petitioner's balance sheets showed the following on the indicated dates:
| Earned | Paid in | |||
| Dec. 31 | Total assets | Cash on hand | surplus | surplus |
| 1940 | $ 7,266,434.66 | $ 131,851.89 | $ 134,113.19 | $ 2,000,416.47 |
| 1941 | 6,820,610.21 | 3,686,027.44 | 106,056.24 | 1,714,553.97 |
| 1942 | 6,787,210.12 | 3,652,627.35 | 72,656.15 | 1,714,553.97 |
| 1943 | 3,098,961.24 | 69,461.24 | 14,407.27 | 284,553.97 |
*30 *913 Petitioner's attorneys advised and supervised the matters involved in the foregoing stockholders' and directors' resolutions. They rendered services in connection with the calling in of the stock, the cancellation and redemption of 22,000 shares thereof, the distribution of $ 3,630,000 in assets, and the issuance of 28,000 shares of new stock. The certificate of reduction of capital stock, the minutes of the stockholders' and directors' meetings, and Treasury Department Form 966 were prepared and, where necessary, filed by them. In reference to these matters they also held discussions in 1945 with a representative of the Bureau of Internal Revenue.
These services were rendered for or on behalf of petitioner, and in 1946 petitioner paid its attorneys $ 20,101.55 for such services, including $ 101.55 as reimbursement of expenses incurred by the attorneys. One-half of this expenditure of $ 20,101.55 was paid for amendment of petitioner's charter, reduction and acquisition of its stock, and issuance of new stock, and was not deductible as an ordinary and necessary business expense. The remaining one-half of this $ 20,101.55 was paid in connection with the distribution of*31 assets in partial liquidation, and was deductible as an ordinary and necessary expense in carrying on a trade or business.
OPINION.
The essential facts are not in dispute. Petitioner is a closely held corporation organized primarily for the two purposes of holding stock in a California corporation, and of acquiring certain improved real estate in New York City. In January 1917, shortly after its formation, it acquired both the stock and the real estate in question. Years later, in March 1941, the real estate was sold for $ 3,625,000.
After considering what to do with the sales proceeds, and after giving thought to the possibility of completely liquidating petitioner, it was decided rather to file a certificate amending the corporate charter by reducing to $ 2,800,000 the then authorized and outstanding capital stock of $ 5,000,000; to distribute to stockholders part of the corporation's assets in exchange for $ 2,200,000 of the outstanding stock to be surrendered; and to issue new capital stock of $ 2,800,000 under the amended charter in exchange for the remaining capital stock outstanding. Corporate funds in the amount of $ 3,630,000 were to be distributed; $ 2,200,000 was to*32 be allocated to the reduction in capital stock, and the remainder of $ 1,430,000 was to be charged to contributed surplus. The course so chosen was executed in 1943, and in 1946 petitioner paid in connection therewith lawyers' fees and incidental legal expenses of $ 20,101.55.
Petitioner's charter provided for perpetual duration, and empowered *914 it to engage in business activities in addition to those for which it was primarily organized. After the execution of this plan, petitioner's authorized and outstanding capital stock amounted to $ 2,800,000. Its total assets, cash on hand, earned surplus, and paid-in surplus prior to the distribution were respectively $ 6,787,210.12, $ 3,652,627.35, $ 72,656.15, and $ 1,714,553.97; thereafter these same items amounted to $ 3,098,961.24, $ 69,461.24, $ 14,407.27, and $ 284,553.97.
The question posed is whether petitioner, which kept its books and filed its returns on a cash basis, was entitled to deduct the legal expense of $ 20,101.55 in 1946 as an ordinary and necessary business expense under section 23 (a) (1) (A) of the Code. 1
*33 The problem presented by the facts of this case falls between two lines of decision that point in opposite directions. On the one hand, it is firmly recognized that the costs incurred in organizing or reorganizing a corporation, or of altering its stock structure, or of selling or disposing of a stock issue, or of acquiring and retiring outstanding stock, are treated as capital expenditures rather than as ordinary and necessary business expenses which are deductible from current income. , appeal dismissed (C. A. 2) ; ; , affd. (C. A. 8) ; ; ; ; , affirmed per*34 curiam (C. A. 2), ; . On the other hand, expenditures incurred in connection with the complete liquidation of a corporation have been held deductible as ordinary and necessary expenses. ; , affirmed in part and reversed in part on other grounds (C. A. 5), ; ; cf. . 2
*35 *915 The expenditures involved herein have characteristics that partake of both lines of decisions. Petitioner's legal expenses were undoubtedly incurred in substantial part in order to amend its charter and reduce authorized capitalization, thereby providing for the acquisition and retirement of its stock followed by the issuance of new stock in reduced amount. This aspect of the transaction certainly brings the case within the first line of authority. However, the actual distribution of assets in partial liquidation was also a significant factor with respect to which the legal fees were paid, and it is difficult to perceive why the cost of a partial liquidation should be any the less an ordinary and necessary business expense than the cost of a complete liquidation.
The record before us does not furnish any satisfactory basis upon which a precise allocation can be made, but, doing the best we can with the material at hand, we find and hold that one-half of the expenditure in question was made with respect to reconstituting the stock of petitioner and related matters, with the result that such one-half must be treated as a nondeductible capital item; and that the other one-half*36 was made with respect to the distribution of assets, which we hold to be deductible. Cf. .
Decision will be entered under Rule 50.
Turner, J., dissenting: Passing over the question still lurking in the background as to whether there has been judicial legislation in Pacific Coast Biscuit Co., 32 B. T. A. 39, and other cases which have followed, to the effect that expenditures incurred in connection with the complete liquidation of a corporation are to be regarded as ordinary and necessary expenses, within the meaning of section 23 (a) of the Code, it is my view that there should be no question about the expenditures in the instant case. They were not expenditures incurred in connection with the complete liquidation of a corporation, but were expenditures incident to the reorganization of a continuing corporation and, under the long line of cases cited in the majority opinion, are capital expenditures which are not deductible and in no way partake of the character of expenditures normally made by the corporation in the ordinary course of conducting*37 the business for which it was originally organized and now reorganized.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
(1) Trade or business expenses. --
(A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, * * *.↩
2. The diversity in results between these two lines of cases may be contrasted with the holdings that expenses incurred in connection with the sale of securities ( ) as well as with the purchase of securities ( ) are capital items, and may not be treated as deductible expenses.↩