*2491 The petitioner's loss from exchange of capital stock of one corporation for capital stock of another corporation, sustained in 1920 and not in 1916 as alleged by respondent.
*890 This is a proceeding for the redetermination of a deficiency in income taxes for the year 1920, amounting to $4,812.89. The sole question is the amount of the loss sustained by the petitioner in 1920 on stock acquired in 1916 as hereinafter set forth.
FINDINGS OF FACT.
Petitioner is an individual formerly of Cleveland, Ohio, now residing in Concord, Mass. At different times during the period December, 1911, to March, 1913, the petitioner purchased shares of the capital stock of two corporations known as the Iceless Refrigerator Co. (hereafter referred to as Refrigerator Company) and Iceless Refrigeration Co. (hereafter referred to as Refrigeration Company) in the amounts and at the times listed below:
| December 1911, Iceless Refrigerator Co | $5,000.00 |
| December 1911, Iceless Refrigeration Co | 25,000.00 |
| August 1912, Iceless Refrigerator Co. and Iceless Refrigeration Co | 15,000.00 |
| March 1913, Iceless Refrigeration Co. | 363.64 |
| 45,363.64 |
*2492 Petitioner loaned the Refrigeration Company $1,526.83 in September, 1913, and $2,000 in October and November, 1914, for which amounts he later accepted common stock of the Iceless Machine Co. *891 (hereafter referred to as Machine Company), therefore, his total investments in stocks of these three companies amounted to $48,890.47.
The value of the petitioner's investments on March 1, 1913, was equal to its cost to him.
The Refrigerator Company was originally formed with small authorized capital stock, for the purpose of holding the patents and to license the right to use those patents to the Refrigeration Company. On August 12, 1912, the Refrigerator Company was dissolved and the stockholders of that company received stock in the Refrigeration Company for their interest.
The Machine Company was organized for the purpose of taking over the assets and operating the business of the Refrigeration Company, and on February 13, 1915, those two companies entered into a memorandum of agreement whereby the Refrigeration Company assigned, transferred and set over to the Machine Company all of its assets except cash and bills and accounts receivable in its possession February 1, 1915. *2493 The assets as specifically provided for in that agreement are as follows:
(a) All its right, title and interest in and to its machinery, tools, equipment, materials and manufactured products now located at its Factory on East 152nd Street, Cleveland, Ohio, or at any of its Agencies or Branches;
(b) Its lease on its present Factory and Factory site located on East 152nd Street, Cleveland, Ohio and such other leases as it may have on property or store-rooms located in Cleveland, Ohio, Buffalo, New York, Pittsburgh, Pennsylvania, Chicago, Illinois and Milwaukee, Wisconsin;
(c) All letters patent, applications for letters patent, inventions, improvements, patent rights, interests in patents of all kinds whether the same be legal or equitable, trade marks and trade names, and the business and good will of the business in connection with which said trade marks and trade names are used, now owned or controlled by the Seller;
(d) All its right, title and interest in and to any and all unfulfilled or outstanding contracts of whatsoever kind, nature and description.
The Machine Company, in accordance with the agreement hereinabove referred to, issued to the Refrigeration Company 550*2494 shares of the series "B" preferred capital stock and 990 shares of common capital stock of the Machine Company which it held until June, 1916. It was further agreed that the Refrigeration Company would proceed to dissolve in accordance with the laws of the State of Ohio as soon as practicable after the full performance of that memorandum of agreement. The cash and accounts and notes receivable retained by the Refrigeration Company were to be used for the payment of the creditors of that company before any sums were paid to the stockholders.
The Refrigeration Company was not dissolved until 1916.
It having been decided to change the capital structure of the Machine Company, on June 29, 1916, prior to the dissolution of the *892 Refrigeration Company, a memorandum of agreement was entered into between the Machine Company and its stockholders and the Refrigeration Company and its stockholders and creditors, providing for reorganization of the Machine Company and, among other things, the elimination of its series "B" preferred stock. This move was considered necessary for the reason that the company was in need of funds. The pertinent parts of the memorandum of agreement*2495 of June 29, 1916, read as follows:
WHEREAS, the Machine Company is in need of additional funds to carry on its business which can be obtained, so far as the parties to this agreement are able to determine, only by a re-organization of the Machine Company which will involve the elimination of its series "B" Preferred Stock, the reduction of its Common Stock and an increase in the preferences and privileges of its Series "A" Preferred Stock; and,
WHEREAS, the Refrigeration Company is indebted to the Creditors in amounts aggregating Thirty-seven Thousand, Eight Hundred Fifty Dollars ($37,850.00). plus interest; and,
* * *
WHEREAS, the stockholders are the owners and holders of all of the issued and outstanding capital stock of the Machine Company, except that which is held by the Trustees, as aforesaid; and,
WHEREAS, in order to effectuate the re-organization of the Machine Company which will bring into it the new capital required for the expansion of its business, it seems advisable that an attempt be made to dispose of the claim of the Chicago Company, and that the co-operation of all of the parties to this agreement be secured in carrying out said plan of re-organization;
*2496 Now, THEREFORE, in consideration of the premises and of the mutual covenants of each of the parties hereto, to the other parties passing, the parties hereto mutually covenant and agree as follows;
I.The Machine Company hereby covenants and agrees that it will furnish to the Refrigeration Company such an amount of cash, not exceeding Five Thousand Dollars ($5,000.00), as may be necessary in order to settle the claim of the Chicago Company against the Refrigeration Company and Machine Company.
II.The Refrigeration Company hereby covenants and agrees that it will immediately endeavor to settle the claim of the Chicago Company upon the most favorable terms possible, not exceeding in any event the payment of Five Thousand Dollars ($5,000.00), in cash.
III.It is mutually understood and agreed among all the parties hereto that the covenants hereinafter set forth are all conditional upon the satisfactory settlement of the claim of said Chicago Company, and that the Parties hereto shall not be bound to take any action upon the succeeding covenants until such settlement shall have been effectuated or its terms agreed upon.
*893 IV.
The stockholders hereby surrender*2497 all the right, title and interest which they or any of them may have in and to any of the Five Hundred (500) shares of the Common Stock of the Machine Company held by the Trustees and agree that the same may be dealt with as set forth in Paragraph VI. of this agreement.
V.The Refrigeration Company and Machine Company hereby mutually covenant and agree that the Trustees shall be relieved from any obligation to hold said Five Hundred (500) shares of the Common Stock of the Machine Company and dispose of the same in accordance with the terms of the agreement dated February 13, 1915, by and between the Refrigeration Company and Machine Company, and agree that the same may be dealt with as set forth in Paragraph VI. of this agreement.
VI.The Trustees hereby covenant and agree that out of the Five Hundred (500) shares of the Common Stock of the Machine Company held by them, they will assign Two Hundred Fifty (250) shares to Jos. H. Champ, to be accepted by him in full settlement of all claims against the Machine Company to date; Two Hundred (200) shares to the Refrigeration Company, and Fifty (50) shares to the Machine Company.
VII.Jos. H. Champ hereby covenants and*2498 agrees that he will accept the Two Hundred Fifty (250) shares of the Common Stock of the Machine Company to be assigned to him by the Trustees in full settlement of all claims against the Machine Company.
VIII.The stockholders hereby covenant and agree that they, severally, will vote for and take all such action as stockholders of the Machine Company as may be considered necessary or advisable by counsel in order to bring about a reduction of the capital stock of said Company and an amendment of its Articles of Incorporation so that it shall have a capitalization of Two Hundred Thousand Dollars ($200,000), of which One Hundred Thousand Dollars ($100,000.00) shall be eight per cent. (8%) Cumulative Preferred Stock, participating pro rata with the Common Stock in all earnings of the Company above eight per cent, (8%) on the Preferred Stock, and divided into One Thousand (1,000) shares of One Hundred Dollars ($100.00) each; and One Hundred Thousand Dollars ($100,000.00) shall be Common Stock, divided into Twenty Thousand (20,000) shares of Five Dollars ($5.00) each, each share of Preferred Stock to be entitled to Twenty (20) votes and each share of Common Stock to one (1) vote, *2499 making equivalent par values of the two stocks equal in voting power; and further, that such reduction and amendment shall be carried out in such a way that the present holders of Series "A" preferred stock of the Machine Company will each have an amount of the Preferred Stock of the re-organized Company equal in par value to their present holdings of said Series "A" preferred stock, and so that the Refrigeration Company shall have Fifty-two Thousand, Five Hundred Dollars ($52,500.00) and Jos. H. *894 Champ Seventy-five Hundred Dollars ($7,500.00) of the Common Stock of the re-organized Company, the remaining Forty Thousand Dollars ($40,000.00) of said Common Stock being unissued in the treasury of the Machine Company.
IX.The Refrigeration Company hereby covenants and agrees that if and when said reduction of capital stock and amendment of Articles of Incorporation of the Machine Company shall have been effected, it will distribute the Fifty-two Thousand, Five Hundred Dollars ($52,500.00) Common Stock of the Machine Company then held by it, in the following manner:
| (a) To each of the Creditors of the Refrigeration Company an amount of said stock equal in par value to approximately Fifty-three per cent (53%) of the amounts of their respective claims against the Refrigeration Company, eliminating fractional shares | $20,040.00 |
| (b) To the holders of the One Hundred Fifty Thousand Dollars ($150,000.00) of the Preferred Stock of the Refrigeration Company an amount of Common Stock which shall be equal in par value to Fifteen per cent (15%) of the par amounts of their respective holdings of said stock | 22,500.00 |
| (c) To the holders of the One Hundred Ninety-nine Thousand, Two Hundred Dollars ($199,200.00) Common Stock of the Refrigeration Company an amount of Common Stock which shall be equal in par value to Five per cent (5%) of the par amounts of their respective holdings of said stock | 9,960.00 |
| Total | $52,500.00 |
*2500 A schedule of the Creditors, Preferred Stockholders and Common Stockholders of the Refrigeration Company, showing the amounts of stock which are to be issued to each of them under the terms of this paragraph, is attached to this agreement, made part hereof and marked EXHIBIT "A".
X.The Creditors hereby covenant and agree that they will accept the amount of stock of the Machine Company set opposite their respective names on Exhibit "A" in full settlement of the claims against the Refrigeration Company and agree to the remainder of said scheme of distribution to Preferred and Common stockholders of the Refrigeration Company.
XI.It is mutually understood and agreed by and between all of the parties hereto that the re-organization, reduction of capital stock and amendment of the Articles of Incorporation of the Machine Company herein provided for is subject to the permission and approval of the appropriate State authorities of the State of Ohio.
* * *
"EXHIBIT *895 A"
SCHEDULE OF DISTRIBUTION OF THE $52,500.00 OF COMMON STOCK OF THE MACHINE COMPANY WHICH WILL BELONG TO THE REFRIGERATION COMPANY AFTER REORGANIZATION OF THE MACHINE COMPANY.
| CREDITORS | |||
| 52.95 per cent of face of claim in common stock, eliminating fractions | |||
| Name | Amount of claim | Par value of stock to be received | Number shares, $5 par each |
| E. A. Foote | $500.00 | $265.00 | 53 |
| G. G. Wade | 1,500.00 | 795.00 | 159 |
| I. H. Wade, Jr | 1,250.00 | 660.00 | 132 |
| G. W. Grandin | 10,000.00 | 5,295.00 | 1,059 |
| A. W. Ellenberger | 1,600.00 | 845.00 | 169 |
| C. C. Bolton | 3,750.00 | 1,985.00 | 397 |
| J. H. Foster | 650.00 | 340.00 | 68 |
| H. P. Bingham | 4,500.00 | 2,385.00 | 477 |
| C. A. Brayton | 3,000.00 | 1,590.00 | 318 |
| H. C. Osborn | 3,000.00 | 1,590.00 | 318 |
| R. S. Spencer | 100.00 | 50.00 | 10 |
| A. Y. Gowen | 6,000.00 | 3,180.00 | 636 |
| W. C. Saeger | 2,000.00 | 1,060.00 | 212 |
| Totals | 37,850.00 | 20,040.00 | 4,008 |
| PREFERRED STOCKHOLDERS | |||
| Three shares machine common ( $5 par) for each share of refrigeration preferred ( $100 par) | |||
| Name | Number shares refrigeration preferred | Number shares machine common to be received | Par value of stock to be received |
| H. P. Bingham | 252 | 756 | $3,780.00 |
| A. Y. Gowen | 727 | 2,181 | 10,905.00 |
| W. C. Saeger | 17 | 51 | 255.00 |
| H. H. Southworth | 54 | 162 | 810.00 |
| G. W. Grandin | 160 | 480 | 2,400.00 |
| H. C. Osborn | 60 | 180 | 900.00 |
| C. A. Brayton | 60 | 180 | 900.00 |
| E. A. Foote | 10 | 30 | 150.00 |
| J. H. Foster | 12 | 36 | 180.00 |
| A. W. Ellenberger | 13 | 39 | 195.00 |
| C. C. Bolton | 75 | 225 | 1,125.00 |
| G. G. Wade | 30 | 90 | 450.00 |
| R. S. Spencer | 5 | 15 | 75.00 |
| J. H. Wade, Jr | 25 | 75 | 375.00 |
| Totals | 1,500 | 4,500 | 22,500.00 |
| COMMON STOCKHOLDERS | |||
| One share machine common ( $5 par) for each share of refrigeration common ( $100 par), eliminating fractions | |||
| Name | Number shares refrigeration common | Number shares machine common | Par value of stock to be received |
| A. Y. Gowen | 671.8 | 671 | $3,355.00 |
| H. H. Southworth | 244 | 244 | 1,200.00 |
| W. C. Saeger | 186 | 186 | 930.00 |
| H. P. Bingham | 204.3 | 204 | 1,020.00 |
| P. Ahlefeld | 120 | 120 | 600.00 |
| A. B. Stuber | 22 | 22 | 110.00 |
| S. B. Chittenden | 22 | 22 | 110.00 |
| Emily E. Saeger | 22 | 22 | 110.00 |
| T. P. Howell | 24.5 | 25 | 125.00 |
| A. P. Brush | 4.9 | 5 | 25.00 |
| W. E. Viets | 4.9 | 5 | 25.00 |
| F. H. Smith | 6.6 | 7 | 35.00 |
| C. B. King | 4.5 | 5 | 25.00 |
| C. A. Brayton | 60.5 | 60 | 300.00 |
| H. C. Osborn | 61 | 61 | 305.00 |
| G. W. Grandin | 161 | 161 | 805.00 |
| J. H. Foster | 14 | 14 | 70.00 |
| A. W. Ellenberger | 13 | 13 | 65.00 |
| C. C. Bolton | 75 | 75 | 375.00 |
| G. G. Wade | 30 | 30 | 150.00 |
| E. A. Foote | 10 | 10 | 50.00 |
| R. S. Spencer | 5 | 5 | 25.00 |
| J. R. Wade, Jr | 25 | 25 | 125.00 |
| Totals | 1,992 | 1,992 | 9,960.00 |
*2502 *896 As a result of the aforementioned memorandum of agreement the capital stock of the Machine Company was reduced to $200,000, divided into $100,000 of 8 per cent cumulative preferred stock $100 par value and $100,000 common stock having a par value $5 per share. The second preferred stock was converted into common stock. The par value of the common stock was not regarded as having any significance as to its actual value, but was adopted in order to provide a large number of shares for distribution among the various parties to avoid fractions.
The debts of the Refrigeration Company amounting to $37,850, the holders of 1,500 shares of preferred stock and 1,992 shares of common stock were staisfied by the payment of the $52,500 of common stock received by the Refrigeration Company from the Machine Company in accordance with the terms of agreement of June 29, 1916.
The petitioner received as his pro rata share of the stock so turned over:
| Number of shares | Total par value | |
| As a note holder | 212 | $1,060.00 |
| As a preferred stockholder | 51 | 255.00 |
| As a common stockholder | 186 | 930.00 |
| 449 | 2,245.00 |
*897 There were no sales of the common*2503 stock of the Machine Company during the years 1915, 1916, and 1917 and no transfers were made except for the purpose of carrying out the reorganization. There were, however, sales of 345 shares of the first preferred stock of the Machine Company at or about the time of reorganization, nearly all of which was sold to the stockholders of the Refrigeration Company - 50 shares were sold to J. H. Champ, president, who was not a stockholder of the Refrigeration Company, for $5,000 cash, and 35 shares to other newcomers. Both the Refrigeration Company and the Machine Company were organized under the laws of the State of Ohio, and the powers granted by their charters were substantially the same.
The principal assets of the Machine Company were its patents and the success of the business depended upon its ability to develop its refrigerating machine commercially. The machine was operated on the absorption principle and was designed for domestic use. Petitioner (also a number of other stockholders and directors) was using one of these machines in his home and was much pleased with his.
Notwithstanding the fact that the Machine Company had been operating at a loss from its inception, *2504 it was constantly attempting to perfect its product and it was believed at all times that success was "just around the corner." It was thought that the machine would prove to be the best on the market.
Upon the dissolution of the Machine Company in 1918, the assets were transferred to a trustee. Some cash was paid to the preferred stockholders and the trustees continued to hold the patents in a holding company. Nothing has been done since that time.
The stock of the Machine Company, as was the case with the Refrigeration Company, was closely held by a few stockholders.
In 1920 the petitioner took as a deduction the total original cost of said securities in the computation of his net income for that year. The respondent on the other hand, allowed only the sum of $2,240, the par value of the shares of stock of the Machine Company held by the petitioner.
OPINION.
MORRIS: Petitioner alleges that the respondent erred in refusing to allow him to deduct the full amount of his original investment of $48,890.47 in capital stock of the Refrigerator Company and the Refrigeration Company in the computation of his net income for 1920. Respondent, on the other hand, contends that*2505 when the Refrigeration Company liquidated in 1916, the petitioner sustained a loss at that time equal to his original investment minus the par value of the stock of the Machine Company received by him in 1916. Petitioner contends that the capital stock of the Machine Company which he received in 1916 had no ascertainable market *898 value, and that there could be no basis for computing a gain or loss realized at that time, therefore, the stock of the Machine Company merely took the place of the stock in the Refrigeration Company, and when the stock of the Machine Company was found to be worthless in 1920, the amount of his loss was the total amount of his original investment in the Refrigeration Company.
As no question is raised as to the worthlessness of the stock in 1920, the sole question for our determination is the amount of the loss sustained at that time. If the transaction in 1916 under which the petitioner acquired the stock was one that gave rise to gain or loss for tax purposes, a new basis was established, that must be used in determining the amount of the loss sustained in 1920. Under the Revenue Act of 1918, (section 202(b)), provision was made that propety*2506 received in exchange for other property shall for the purpose of determining gain or loss, be treated as the equivalent of cash to the amount of its fair market value if any, and the later acts provide that income arises out of an exchange only when the property received has a readily realizable market value. Clearly under those acts, before gain or loss arises, that which is received must be equivalent of cash, or readily convertible into cash. No such specific provisions appear however in the Revenue Act of 1916 and the principle embodied in the later acts is inapplicable unless it is inherent in the theory of income taxation, and therefore included in the more general terms of the 1916 Act. In , the Supreme Court, after defining income, stated:
Here we have the essential matter; not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property.
In ; affirmed *2507 , arising under the 1916 statute, the court said, "nevertheless, by and large, the statute means what it says, and that is that the tax is to be levied on nothing else except gains, profits, and income, and upon them only when actually realized in money or in money's worth." See also ; 6 Am.Fed. Tax Rep. 6681. From these decisions it is clear that under the 1916 Act there must be a realization before gain arises and the principle is equally applicable before a loss can be sustained.
It follows, therefore, that if the petitioner had received cash, or property which could have readily been converted into cash in 1916, gain or loss could have been definitely determined. It is equally obvious that if the property received by the petitioner had no fair market value of fair value, or any value other than that which it *899 had to him, there is no basis upon which to predicate a gain or loss within the spirit and intent of the taxing statutes and that, therefore, any gain or loss that he sustained must be determined when the transaction has been completed by the sale of the property for*2508 cash or other property which has some fair market value.
The respondent has used, in determining what he alleges to be a loss in 1916, the par value of the shares received by petitioner in exchange for his original investment in the Refrigeration Company. In this we can see no justification. Par value of stock is no evidence of the value of property. .
The testimony clearly shows that the principal asset of the Machine Company was its patent on the refrigerator machine it was manufacturing and that the success or failure of the company depended upon that patent - if the company's machine proved to be commercially successful for domestic use then of course its patent and likewise its capital stock would be of inestimable value, but on the other hand, if, as it later developed, the machine could not be perfected, then the patent and likewise the stock of that company would be practically worthless. The Machine Company had certainly not abandoned hope in 1916, since, as the testimony shows, in 1915 and 1916 the company was reorganized and readjusting itself to carry on the work that had been conducted by the Refrigeration*2509 Company and at all times it appeared to the stockholders that success was "just around the corner."
There were no sales of the common stock of the Machine Company during the years 1915, 1916, and 1917 and no transfers of stock were made. In fact the stock of the company was closely held by a small group of individuals. Petitioner testified that so far as he could ascertain, no bids of offers had ever been made for the stock of the Machine Company. In our opinion, the stock received by the petitioner in 1916 had no exchangeable value or fair market value, and he did not at that time therefore sustain a loss of a part of his investment. When the stock became worthless in 1920 his total investment was gone, as a result of which he may deduct the amount thereof, or $48,890.47, in his income-tax return for that year.
Reviewed by the Board.
Judgment will be entered for the petitioner on 10 days' notice, under Rule 50.