*1839 Where, pursuant to a plan of reorganization, common stock in one corporation is exchanged solely for common stock in another corporation, preferred stock is sold for cash, and additional stock is purchased by exercising stock rights, it is held that under the provisions of section 203(b)(2) of the Revenue Act of 1926 no gain or loss should be recognized from the exchange of common stock for common stock, that there is a realization of profit from the sale of preferred stock in an amount equal to the difference between the sale price and the cost or March 1, 1913, value, and that no profit is realized upon the purchase of additional stock of the reorganized corporation.
*549 The respondent has determined deficiencies in income taxes against A. W. Leonard, J. H. Evans, and Harry Heasley for the calendar year 1925 in the respective amounts of $7,132.18, $7,368.97, and $11,573.36. The deficiencies arise from the respondent's determination that the exchange of common stock of the Devonian Oil Co. for stock of the Oklahoma*1840 Eastern Oil Co., the sale of Devonian preferred stock to the Oklahoma Co. for cash, and the exercise of rights to subscribe for new stock of the Oklahoma Co. constitute a single transaction coming within the provisions of section 203(d)(1) of the Revenue Act of 1926. The petitioners allege that the only gain to be recognized from the reorganization is represented by the difference between the cost and sale price of the preferred stock, the exchange of Devonian common stock for stock of the Oklahoma Co. being a transaction from which no gain or loss will be recognized under the provisions of section 203(b)(2) of the Revenue Act of 1926, and the stock acquired by the exercise of rights not having been disposed of, no gain resulted therefrom.
At the close of the hearing, counsel for the respondent was permitted to amend his answer as to each of the petitioners Leonard and Heasley by adding thereto a request that the Board find deficiencies in greater amounts than those set forth in the deficiency *550 notices. The three proceedings, which have previously been consolidated by order for hearing and decision, are submitted on evidence adduced at the hearing, and the following*1841 stipulation of facts.
STIPULATION OF FACTS.
The Devonian Oil Co. and the Oklahoma Eastern Oil Co. were merged as of March 2, 1925.
The Devonian Oil Co. was a corporation organized June 3, 1920, under the laws of the State of Delaware, with offices in Tulsa, Okla. Its authorized capital stock was 60,000 shares of preferred stock of a par value of $25 per share and 60,000 shares of common stock, having no par value. As of March 2, 1925, the effective date of the merger with the Oklahoma Eastern Oil Co., there were issued and outstanding 40,000 shares of preferred stock, par value at $25 per share and 40,000 shares of common stock, no par value.
The Oklahoma Eastern Oil Co. was a corporation organized May 23, 1922, under the laws of the State of Oklahoma, with offices at Tulsa, Okla. Under its charter, there were authorized 1,200,000 shares of common stock, par value $1 per share. On March 2, 1925, before the merger with the Devonian Oil Co., and before the increase in the capital stock required under the merger agreement, there were issued and outstanding 1,144,000 shares of common stock, par value $1 per share, and of a then market value of $1.50 per share. There was*1842 no authorized, issued or outstanding preferred stock.
On December 29, 1924, pursuant to negotiations looking toward the merger or consolidation of the Oklahoma Eastern Oil Co. and the Devonian Oil Co., at a meeting of the directors of the Oklahoma Eastern Oil Co., a resolution was passed submitting a plan of merger or consolidation to the stockholders of the Oklahoma Eastern Oil Co. and the stockholders of the Devonian Oil Co.
On February 24, 1925, the plan (authorized by the board of directors at its meeting on December 29, 1924) was submitted to the stockholders of the Oklahoma Eastern Oil Co. for their action.
No official record was made of a meeting of the directors or stockholders of the Devonian Oil Co. concerning any action taken with respect to the plan as set forth in the minutes of the Oklahoma Eastern Oil Co. There was a close relationship existing between the officers and stockholders of the two corporations. Prior to the merger 59 out of a total of 1,122 stockholders of the Devonian Oil Co. owned shares of the stock of the Oklahoma Eastern Oil Co. Said 59 Devonian stockholders then owned 245,719 out of the total 1,144,000 then issued shares.
A merger of*1843 the stock and properties of the Devonian Oil Co. and the Oklahoma Eastern Oil Co. took place on March 2, 1925.
*551 The individual petitioners in the above entitled three consolidated appeals, to wit: A. W. Leonard, J. H. Evans, and Harry Heasley, were, on January 1, 1925, and prior thereto, stockholders of the Devonian Oil Co., Tulsa, Okla., and of the Oklahoma Eastern Oil Co., Tulsa, Okla. They continued to be stockholders in said Devonian Oil Co. until said corporations were merged or consolidated as of March 2, 1925. Petitioners were the owners, of record and in fact, of the following shares of stock of the Devonian Oil Co. and the Oklahoma Eastern Oil Co., prior to said merger of the Devonian Oil Co. and the Oklahoma Eastern Oil Co. on March 2, 1925, as follows: A. W. Leonard owned 6,239 shares of preferred stock, and 6,878 shares of common stock of the Devonian Oil Co., and 1,608 shares of Oklahoma Eastern Oil Co.; J. H. Evans owned 2,355 shares of preferred stock, and 4,500 shares of common stock of the Devonian Oil Co., and 40 shares of Oklahoma Eastern Oil Co.; Harry Heasley owned 8,000 shares of preferred stock, and 7,050 shares of common stock of the Devonian*1844 Oil Co., and 5,000 shares of Oklahoma Eastern Oil Co.
The petitioner, A. W. Leonard, on March 12, 1925, surrendered his stock of the Devonian Oil Co., consisting of 6,878 shares of common stock and 6,239 shares of preferred stock, to the Oklahoma Eastern Oil Co. He received in exchange for the said common stock 85,975 shares of the stock of the Oklahoma Eastern Oil Co. Before the merger he was also the owner of 1,608 shares of the stock of the Oklahoma Eastern Oil Co. On March 12, 1925, he exercised his rights to subscribe for 87,583 additional shares of the stock of the Oklahoma Eastern Oil Co.
The summary of the foregoing follows, it being agreed that he received the stock and checks on the dates specified in the summary, to wit:
| Shares | ||
| Oklahoma | ||
| Eastern Oil Co. | ||
| stock | ||
| 6,878 shares Devonian common exchanged on basis | ||
| of 12 1/2 for one | 85,975 | |
| Rights exercised to subscribe for one share for | ||
| each share of Oklahoma Eastern Oil Co., held | ||
| after exchange | 85,975 | |
| Shares stock of Oklahoma Eastern Oil Co. received | ||
| thereby | 171,950 | |
| 6,239 shares of preferred stock of Devonian Oil | ||
| Co., turned in at $25 per share | $155,975.00 | |
| Credit subscription for additional stock of | ||
| Oklahoma Eastern Oil Co. under rights | 85,975.00 | |
| Balance | $70,000.00 | |
| Additional subscription Oklahoma Eastern Oil Co. | ||
| stock by virtue of being a stockholder previously | 1,608.00 | |
| Balance | $68,392.00 | |
| Check paid to A. W. Leonard by Oklahoma Eastern | ||
| Oil Co., 3-13-25 | $10,000.00 | |
| Check paid to A. W. Leonard by Oklahoma Eastern | ||
| Oil Co., 3-25-25 | 58,392.00 | |
| $68,392.00 |
*1845 *552 The petitioner, J. H. Evans, on March 12, 1925, surrendered his stock of the Devonian Oil Co., consisting of 4,500 shares of common stock, and 2,355 shares of preferred stock to the Oklahoma Eastern Oil Co. He received in exchange for said common stock, 56,250 shares of stock of Oklahoma Eastern Oil Co. Before the merger he was also the owner of 40 shares of the stock of the Oklahoma Eastern Oil Co. On March 12, 1925, he exercised his rights to subscribe for 56,290 additional shares of the stock of the Oklahoma Eastern Oil Co.
A summary of the foregoing follows, it being agreed that he received the stock and the check at the time specified in the summary, to wit:
| Shares, | |
| Oklahoma | |
| Eastern Oil Co. | |
| stock | |
| 4,500 shares Devonian common, exchanged on basis of 12 1/2 | |
| for one | 56,250 |
| Rights exercised to subscribe for one share for each share | |
| of Oklahoma Eastern Oil Co. held after exchange | 56,250 |
| Shares stock of Oklahoma Eastern Oil Co. received thereby | 112,500 |
| 2,355 shares of preferred stock of Devonian Oil Co., turned | |
| in at $25 per share | $58,875 |
| Credit subscription for additional stock of Oklahoma Eastern | |
| Oil Co. under rights | 56,250 |
| Balance | $2,625 |
| Additional subscription Oklahoma Eastern Oil Co. stock by | |
| virtue of being stockholder previously | 40 |
| Check during year 1925 paid J. H. Evans by Oklahoma Eastern | |
| Oil Co | $2,585 |
*1846 The petitioner, Harry Heasley, on March 12, 1925, surrendered his stock of the Devonian Oil Co., consisting of 7,050 shares of common stock and 8,000 shares of preferred stock to the Oklahoma Eastern Oil Co. He received in exchange for the said common stock, 88,125 shares of the stock of the Oklahoma Eastern Oil Co. Before the merger he was also the owner of 5,000 shares of the stock of the Oklahoma Eastern Oil Co. On March 12, 1925, he exercised his rights to subscribe for 88,125 additional shares of the stock of the Oklahoma Eastern Oil Co.
A summary of the foregoing follows, it being agreed that he received the stock and check at the time specified in the summary, to wit:
| Shares, | |
| Oklahoma | |
| Eastern Oil Co. | |
| stock | |
| 7,050 shares Devonian common exchanged on basis of 12 1/2 | |
| for one | 88,125 |
| Rights exercised to subscribe for one share for each share | |
| of Oklahoma Eastern Oil Co. held after exchange | 88,125 |
| Shares stock of Oklahoma Eastern Oil Co. received thereby | 176,250 |
| 8,000 shares of preferred stock of Devonian Oil Co., turned | |
| in at $25 per share | $200,000 |
| Credit subscription for additional stock of Oklahoma Eastern | |
| Oil Co. under rights | 88,125 |
| Balance | $111,875 |
| Additional subscription Oklahoma Eastern Oil Co. stock by | |
| virtue of being a stockholder, previously | 5,000 |
| Check during year 1925 paid to Harry Heasley by Oklahoma | |
| Eastern Oil Co | $106,875 |
*1847 *553 As to the other stockholders, it is agreed that:
Certain owners of common stock in the Devonian Oil Co. owned no preferred stock in said company, and pursuant to the merger exchanged their stock as follows, on March 12, 1925:
| Name | Owned | Received |
| shares in | shares in | |
| Devonian | Oklahoma | |
| Oil Co. | Eastern | |
| Oil Co. | ||
| in | ||
| exchange | ||
| Bleakley Corporation | 20 | 250 |
| H. R. Dean | 100 | 1,250 |
| W. E. Lofton | 100 | 1,250 |
| M. J. Evans | 500 | 6,250 |
| Exchange Trust Co., trustee | 1,000 | 12,500 |
Of the above owners of common stock, the following persons exercised their rights to subscribe for additional shares in Oklahoma Eastern Oil Co. and paid for their subscription in cash, as follows:
| Name | Shares received | Amount | Date paid |
| under | paid | ||
| rights | |||
| provisions | |||
| Bleakley Corporation | 250 | $250.00 | Mar. 23, 1925 |
| W. R. Dean | 1,250 | 1,250.00 | Mar. 17, 1925 |
| W. E. Lefton | 1,250 | 1,250.00 | Mar. 17, 1925 |
It is also agreed that: Certain owners of preferred stock in the Devonian Oil Co. did not own any common stock of said Devonian Oil Co., but owned preferred stock as follows:
| Name | Number of |
| shares | |
| Charles E. Cummings | 500 |
| Ruth L. Dean | 400 |
| Gertrude Heasley | 34 |
| Lydia A. Heasley | 40 |
| Nell P. Heasley | 100 |
| Mary M. Leonard | 319 |
| Leo E. McLaughlin | 500 |
*1848 *554 The above owners of preferred stock of the Devonian Oil Co., who owned no common stock thereof, surrendered their preferred stock under the merger transactions, and received payment therefor as follows:
| Name | Number | Date | Amount | How | When |
| of | Surrendered | paid | paid | paid | |
| Charles E. Cummings 1 | 500 | Aug. 26, 1925 | $13,000 | Checks | Aug. 26, 1925 |
| Ruth L. Dean | 400 | Apr. 6, 1925 | 10,000 | do | Apr. 6, 1925 |
| Gertrude Heasley | 34 | Mar. 18, 1925 | 850 | do | Mar. 18, 1925 |
| Lydia A. Heasley | 40 | do | 1,000 | do | Do. |
| Nell P. Heasley | 100 | do | 2,500 | do | Do. |
| Mary M. Leonard | 319 | Mar. 25, 1925 | 3 7,881 | do | Mar. 25, 1925 |
| Leo M. McLaughlin 2 | 500 | Aug. 26, 1925 | 15,500 | do | Aug. 26, 1925 |
*1849 Ada Durham, another stockholder who owned common and preferred stock, upon the surrender of 357 shares of preferred stock which she owned, was paid $208.25 in addition to the par value of $25 per share as accrued interest.
One William J. Levy, who owned both common and preferred stock of the Devonian Oil Co., exchanged 474 shares of common stock of the Devonian Oil Co. for 5,925 shares of Oklahoma Eastern Oil Co. on March 12, 1925, and subscribed for 5,925 additional shares of Oklahoma Eastern Oil Co., which he received on March 26, 1925, upon payment of him by his personal check. He also owned 474 shares of preferred stock of Devonian Oil Co. stock, which he delivered to the Oklahoma Eastern Oil Co. on March 26, 1925, and for which the Oklahoma Eastern Oil Co. paid him $11,850 (or $25 per share), plus $2,370 or an additional $5 per share, plus $68.46 as accrued interest, or a total of $14,288.46, by acceptance and payment of a draft attached to said stock for the 474 shares of preferred stock.
The exhibits received in connection with the above stipulation, in so far as they are material to the issues herein, provide as follows:
Exhibit "C" (Resolution adopted by the Board*1850 of Directors of the Oklahoma Eastern Oil Company on December 29, 1924)
RESOLVED, That this Board hereby approves an increase in the capital stock of the Oklahoma Eastern Oil Company from 1,200,000 shares, of par value $1.00 per share, to 3,300,000 shares of par value $1.00 per share, and also approves *555 the plan of consolidation of the Devonian Oil Company with the Oklahoma Eastern Oil Company as presented, to-wit:
The present outstanding capitalization of the Oklahoma Eastern Oil Company consists of 1,144,000 shares of par value $1.00 per share. Of the new stock authorized, 500,000 shares to be exchanged for the Devonian Oil Company common stock. The Oklahoma Eastern Oil Company will then have outstanding 1,644,000 shares, and will offer to its stockholders a like amount, or 1,644,000 shares of par value $1.00 per share.
It is understood that the stockholders of the Devonian Oil Company, having received the aforesaid 500,000 shares of stock of the Oklahoma Eastern Oil Company in exchange for 40,000 shares of the Common stock of their Company, shall be entitled to subscribe for stock of the Oklahoma Eastern Oil Company on the same basis as its other stockholders.
*1851 In lieu of cash payments for the additional 500,000 shares of Oklahoma Eastern Oil Company stock to be issued to the stockholders of the Devonian Oil Company, they, the stockholders last mentioned, will turn over preferred stock in said Company to the stockholders of the Oklahoma Eastern Oil Company and said preferred stock shall be accepted on the basis of Twenty-five shares of Oklahoma Eastern Oil Company stock for each share of Devonian Oil Company preferred stock; and it is understood that the balance of the outstanding preferred stock of the Devonian Oil Company will be disposed of by the stockholders of the Devonian Oil Company on the basis of Twenty-five Dollars ($25.00) per share.
It is further understood that after the exchange of stock above mentioned is accomplished, the consolidated companies or their successor in name and title, to wit: The Oklahoma Eastern Oil Company, will have on hand, in cash, additional working capital, derived from the sale of stock, the sum of $644,000.00; and that there will be outstanding 3,288,000 shares of the stock of said Oklahoma Eastern Oil Company, leaving unissued 12,000 shares of the capital stock thereof.
BE IT FURTHER RESOLVED, *1852 That a meeting of the stockholders of the Oklahoma Eastern Oil Company shall be called for the purpose of submitting to them for their consideration the consolidation of the Devonian Oil Company with the Oklahoma Eastern Oil Company, the date of this meeting to be determined by the officers of the Company; and
* * *
EXHIBIT F
OKLAHOMA EASTERN OIL COMPANY,
P.O. Box 1483, Tulsa, Oklahoma,
March 2, 1925.
TO THE STOCKHOLDERS OF THE OKLAHOMA EASTERN OIL COMPANY:
At a meeting of the stockholders of the Oklahoma Eastern Oil Company held in Tulsa, Oklahoma, on February 24, 1925, resolutions were unanimously adopted authorizing an increase in the Capital Stock of the Company from 1,200,000 shares of par value $1.00 per share to 3,300,000 shares of par value $1.00 per share, and approving the plan recommended by the Board of Directors for a consolidation of the Oklahoma Eastern Oil Company with the Devonian Oil Company.
Each stockholder of record at the close of business on March 2, 1925, is entitled to subscribe at $1.00 per share for one share of new stock for each *556 share held on that date; payment to be made in full on or before April 1, 1925. Subscription*1853 warrant for that purpose is enclosed herewith. The foregoing right of subscription will expire at the close of business on April 1, 1925.
On the back of the warrant are two forms. In case it is desired to purchase stock, the first form is to be filled out and signed by the stockholder, or by his assigns, and returned on or before April 1, 1925 to the Treasurer of the Oklahoma Eastern Oil Company, P.O. Box No. 1483, Tulsa, Oklahoma, accompanied by a cashier's draft or certified check drawn to the order of the Oklahoma Eastern Oil Company for the full amount payable. In case it is desired to dispose of the privilege of purchasing the stock, the second form on the back of the warrant, which is an assignment, is to be filled out, signed by the stockholder, and witnessed.
Any stockholder who may wish to purchase a portion of the stock covered by the warrant and dispose of the remainder, or who may wish to dispose of a portion of the stock covered by the warrant to one person and the remainder to another, must on or before March 20, 1925 return the warrant to the Treasurer, duly endorsed for transfer, to be exchanged for other warrants, specifying in writing the number of warrants*1854 desired in exchange, the amount of stock to be covered by each, and the name, or names, in which to be issued.
Upon surrender of the warrant and payment of the full purchase price on or before April 1, 1925, temporary certificates representing the amount of stock purchased will be forwarded to the purchaser.
The plan of consolidation as approved by the Board of Directors and Stockholders, is as follows:
The capitalization of the Devonian Oil Company consists of 40,000 shares of preferred stock of par value $25.00 per share and 40,000 shares of common no par stock. The present outstanding capitalization of the Oklahoma Eastern Oil Company consists of 1,144,000 shares of par value $1.00 per share. Of the new stock authorized, 500,000 shares is being exchanged for the Devonian Oil Company common stock. After this exchange, the Oklahoma Eastern Oil Company will have outstanding 1,644,000 shares and offers to its stockholders a like amount or 1,644,000 shares of par value $1.00 per share, on a pro rata basis.
Devonian Oil Company stockholders, having received 500,000 shares of stock of the Oklahoma Eastern Oil Company in exchange for their Devonian common stock, have the right*1855 to subscribe for an equal amount of the new stock at $1.00 per share. In lieu of cash payment, however, for this additional 500,000 shares, preferred stock of the Devonian Oil Company will be accepted on the basis of $25.00 per share, and the balance of the Devonian Oil Company preferred stock will be retired at $25.00 per share.
This will leave additional cash working capital for the consolidated company of $644,000.00. There will be outstanding 3,288,000 shares of Oklahoma Eastern Oil Company stock of par value $1.00 per share and 12,000 shares unissued. At a later date, the par value per share of the stock will be increased.
By this consolidation the Company production will be approximately doubled; the oil acreage will be increased from 19,128 to 49,228 acres; cash working capital will be increased from $150,000.00 to approximately $900,000.00, and the personal interest of the Devonian organization will be obtained in the consolidated company. Your Board of Directors and other stockholders who are familiar with the operations of both companies heartily recommend to you the purchase of this stock.
*557 Stockholders are requested to be punctual in exercising their*1856 right in respect to warrant as the same will become wholly void and of no value after April 1, 1925.
All letters and inquiries in regard to any of the above mentioned matters or details connected therewith should be addressed to the Treasurer, Oklahoma Eastern Oil Company, P. O. Box No. 1483, Tulsa, Oklahoma.
Respectfully submitted.
BOARD OF DIRECTORS.
From the testimony produced and from facts contained in the record we make the following findings of fact.
FINDINGS OF FACT.
The petitioners Leonard and Evans are individuals residing at Tulsa, Okla. The petitioner, Heasley, is an individual residing at Emlenton, Pa.
The Oklahoma Eastern Oil Co. is an outgrowth of the Oklahoma Natural Gas Co., a large public utility, serving Oklahoma communities with natural gas, having been organized to take over the oil properties of that company. The stockholders and directors of the Oklahoma Eastern Oil Co. were closely affiliated with the stockholders and directors of the Devonian Oil Co. The oil properties of the two companies were situated in the same territory. The officers of the Oklahoma Eastern Oil Co. were not familiar with the oil business since their interest had*1857 been chiefly in development and distribution of natural gas. The officers of the Devonian Oil Co. were thoroughly familiar with the oil situation in the Mid-Continent field and by consolidation of the two companies their services were obtained for the Oklahoma Eastern Oil Co.
In carrying out the plan of consolidation the Devonian Oil Co. stock was deposited at that company's office and notice was immediately sent to the Oklahoma Eastern Oil Co. that the stock had been received. Stock of the Oklahoma Co. was then set aside for the Devonian stockholders who had deposited their stock. By March 2, 1925, sufficient stock had been deposited to assure consummation of the proposed consolidation. To facilitate the transaction and save sending out checks to pay for the preferred stock to parties from whom checks would be received in payment of the new common stock, the method was adopted of crediting the price of the preferred stock against the subscription price of the new stock. The balance was paid or received in cash.
In computing the deficiencies herein involved the respondent has adopted two different interpretations of the facts disclosed. The following excerpts from the statements*1858 attached to the deficiency letters show what the respondent has done:
*558 A. W. LEONARD
The taxable profit has, therefore, been computed in accordance with the provisions of Section 203(d)(1) of the Revenue Act of 1926 as follows:
| Cash received (2,800 shares of preferred stock at | ||
| $25.00 per share) | $70,000.00 | |
| 171,950 shares of new stock received market value | ||
| $1.50 per share | 257,925.00 | |
| Total | $327,925.00 | |
| Cost of 2,800 shares of preferred stock | $53,978.20 | |
| Cost of 10,317 shares of common stock | 66,296.80 | |
| 120,275.00 | ||
| Total profit | $207,650.00 | |
| Taxable profit limited to the extent of cash received | $70,000.00 | |
| Amount reported | 16,021.90 | |
| Additional capital gain | $53,978.10 |
1. Your capital gain has been increased by $58,875.00 representing cash at $25.00 a share for preferred stock of the Devonian Oil Co. through the consolidation of this company with the Oklahoma Eastern Oil Co.
In accordance with the terms of the resolution of the consolidation, the taxable profit has been computed under the provisions of Section 203(d)(1) of the Revenue act of 1926 as follows:
| Cash received for 2365 shares of preferred stock at | ||
| $25.00 per share | $58,875.00 | |
| 56.250 shares of new stock at $1.50 per share | 84,375.00 | |
| Total | $143,250.00 | |
| Cost of 2355 shares of preferred stock | $58,875.00 | |
| Cost of 4500 shares of common stock | None. | |
| 58,875.00 | ||
| Total profit | $84,375.00 | |
| Taxable profit limited to the extent of cash received | $58,875.00 |
*1859 HARRY HEASLEY
In the light of the resolution adopted by the stockholders at the time the plan of consolidation was considered and upon the basis of the facts and evidence of record, it is the opinion of this office that the carrying out of the purposes necessary to the consolidation of the two companies must be considered as a whole for the purpose of reorganization. Inasmuch as a reorganization clearly took place, as that term is defined in Section 203(h)(1) of the Revenue Act of 1926, it is held that a taxable gain resulted to you which is computed under the provisions of Section 203(d)(1) of the statute. Such gain, however, is limited to the cash received of $111,875.00.
OPINION.
LANSDON: The controversy in this proceeding arises from different interpretations of section 203 of the Revenue Act of 1926 as applied to the facts stated above. Section 203 provides in part:
*559 (b) (2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
(d) (1) *1860 If an exchange would be within the provisions of paragraph (1), (2), or (4) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
(h) As used in this section and sections 201 and 204 -
(1) The term "reorganization" means (A) a merger or consolidation * * *.
In computing the deficiencies herein involved, the respondent has cut through the form by which the Devonian Oil Co. was consolidated with the Oklahoma Eastern Oil Co. and has determined that there was an exchange of stock in one corporation for stock of another corporation plus cash, and that under the provisions of section 203(d)(1) gain will be recognized to the extent of the cash received.
The petitioners contend that there was an exchange of common stock of the Devonian Co. for stock of the Oklahoma Co., a purchase of new stock by the exercise of stock rights, and a sale of Devonian*1861 preferred stock for cash, which for taxation purposes will be regarded as separate and distinct transactions. They contend that, under the provisions of section 203(b)(2), no gain will be recognized from the exchange of stock for stock; that the purchase of stock by exercising stock rights does not give rise to a taxable profit; and that the sale of Devonian preferred stock resulted in gain only to the extent by which the sale price exceeded the cost or March 1, 1913, value, as provided in section 204(a) of the Revenue Act of 1926.
Although the respondent has applied section 203(d)(1) as to each of the petitioners, he has adopted two conflicting interpretations of the facts. From the computations set out in our findings, it appears that as to the petitioner Evans, he has regarded as cash received the total sale price of the preferred stock and has disregarded the new stock acquired by the exercise of stock rights. As to the other petitioners he adopts the view that there was an exchange of common and preferred stock of the Devonian Oil Co. for stock of the Oklahoma Eastern Oil Co. plus cash. He considers as stock received in exchange for Devonian common and preferred the *560 *1862 total number of Oklahoma Eastern Oil Co. shares received, which includes the stock acquired by the exercise of stock rights accruing to the new stock. The balance of the sale price of the preferred stock is considered as cash received, although a part of such amount was used to pay for new stock acquired by the exercise of stock rights accruing to the stock owned prior to the reorganization.
In effecting a reorganization of the two companies a definite plan was adopted, calling for an exchange of Oklahoma Eastern Oil Co. stock for Devonian common stock and the purchase of Devonian preferred stock for cash. In order to raise the necessary capital with which to retire the preferred stock, additional stock was sold for cash by the Oklahoma Co.
Certain Devonian stockholders, including these petitioners, owned both common and preferred stock, as well as stock in the Oklahoma Eastern Oil Co. To facilitate the transactions in such cases where the stockholders elected to accept the respective offers, the purchase price of the new stock was charged against the sale price of the preferred and the balance was paid in cash. There were stockholders, however, who owned only one class of*1863 stock. They paid cash for the new stock or received cash for their preferred stock.
Our interpretation of the facts presented is in accord with the petitioners' contentions. Prior to the reorganization each petitioner owned two distinct classes of property, namely, common stock and preferred stock. Under the provisions of the revenue act, each had a separate basis upon which to compute gain or loss. If either or both were sold, profit would be computed upon such separate basis. If the preferred stock were sold for cash and the common stock retained, profit would be computed by subtracting the basis for the preferred stock from the sale price, without regard to the common stock. We think the same method should be followed when the preferred stock is sold for cash and the common stock exchanged for common stock pursuant to a plan of reorganization. Section 203(b)(2) provides that no gain shall be recognized if stock in a corporation a party to a reorganization is exchanged solely for stock in another corporation a party to the reorganization. The facts are clear that the Devonian common stock was exchanged solely for stock in the Oklahoma Eastern Oil Co., which transaction, *1864 we think, comes squarely within the provisions of section 203(b)(2).
Each of the petitioners exercised his rights to subscribe for new stock of the Oklahoma Eastern Oil Co. on the basis of one share for each share held. Although the market value of the stock acquired was $1.50 per share and the subscription price $1 per share, there was no realization of profit from the transaction. .
*561 The preferred stock was sold for cash and each of the petitioners realized a profit, if any, equal to the difference between the sale price and the basis provided in section 204(a) of the Revenue Act of 1926.
Reviewed by the Board.
Decision will be entered under Rule 50.
STERNHAGEN and MURDOCK dissent.
Footnotes
1. Charles E. Cummings, upon the surrender of his 500 shares of preferred stock, was paid $500 in addition to the par value thereof of $25 per share, as six months' interest at 8 per cent on $12,500. ↩
3. Being $7,975, less a debit. ↩
2. Leo M. McLaughlin, upon the surrender of his 500 shares of preferred stock, on August 6, 1925, was paid the par value thereof, $25 per share, and a bonus of $2,500 and $500 additional as six months' interest on $12,500. ↩