*11 Decision will be entered under Rule 50.
In 1924 and 1929 petitioner issued nontaxable preferred stock dividends based on post-1913 earnings and profits. Prior to the taxable year it had redeemed all except 12,000 shares of this preferred stock. During the taxable year ending January 31, 1937, it retired the remaining 12,000 shares, paying $ 10 a share over par as a premium, and claimed a dividends paid credit under section 27 (f) of the Revenue Act of 1936 for the full amount paid to retire such stock. Held:
(1) Petitioner is entitled to a dividends paid credit for the amount paid to retire the stock which is in excess of the paid-in capital standing behind such stock. The paid-in capital standing behind such stock is that portion of the capital structure represented by the ratio of the paid-in capital to the entire outstanding capital. August Horrman, 34 B. T. A. 1178, followed.
(2) Petitioner is entitled to a dividends carry-over credit for the fiscal year ending January 31, 1938.
*12 *293 The respondent determined deficiencies against petitioner in income taxes for the taxable years ending January 31, 1937 and 1938, in the respective amounts of $ 85,670.71 and $ 90,541.54. The principal issue is whether petitioner is entitled to a dividends paid credit under section 27 (f) of the Revenue Act of 1936, by reason of the retirement of preferred stock during the taxable year ending January 31, 1937. There is also raised the subsidiary question whether petitioner is entitled to a dividends carry-over credit for the year ending January 31, 1938, as a result of the retirement of stock in the previous year. The issue relative to the deduction of a reserve for bad debts for the year ending January 31, 1937, has been abandoned by petitioner.
FINDINGS OF FACT.
We adopt as a part of the findings of fact the stipulation of the parties, which is substantially as follows:
Petitioner was organized as an Ohio corporation on or about January 4, 1906, and has continued as a corporation duly constituted and authorized to do business under the laws of the State of Ohio since that time.
The predecessor of the petitioner was a partnership conducted under the same or a similar*13 name, and petitioner and its predecessor have been engaged in business in Columbus, Ohio, in the sale of merchandise at retail continuously since 1851. At all the times hereinafter mentioned petitioner was conducting a department store.
On June 26, 1924, the stockholders of petitioner adopted a resolution to increase the authorized capital stock of petitioner from $ 2,500,000 to $ 3,000,000, of which 20,000 shares of the par value of $ 100 each were common stock and 10,000 shares of the par value of $ 100 each were 8 percent preferred stock.
*294 On June 30, 1924, the directors of petitioner authorized the payment of a stock dividend in preferred stock, to the holders of the common stock, at the rate of one-half share of the authorized 8 percent preferred stock to the holder of each share of common stock. This stock dividend was issued on July 1, 1924, pursuant to the resolution of the board of directors.
On July 1, 1924, immediately prior to the issue of the 10,000 shares of 8 percent preferred stock as a stock dividend, the earnings and profits of petitioner accumulated and undistributed since February 28, 1913, were substantially in excess of $ 1,000,000. When the 8 percent*14 preferred stock was issued as a stock dividend the earned surplus account was charged on the books of petitioner with the sum of $ 1,000,000 and the capital account was increased on the books in the same amount.
On January 30, 1929, the stockholders of petitioner adopted a resolution authorizing the following:
(a) The exchange of the outstanding 8 per cent preferred stock (issued as a stock dividend on July 1, 1924) for new 6 1/2 per cent preferred stock on a share for share basis;
(b) The issuance of an additional 40,000 shares of new 6 1/2 preferred stock of the par value of $ 100 each; and
(c) The exchange of the outstanding 13,000 shares of $ 100 par common stock for 350,000 shares of new no par value common stock. (Seven thousand shares of the old common stock had been retired in 1927, and $ 700,000 had been paid or credited to the stockholders when it was retired.)
On January 30, 1929, the directors of the petitioner authorized the same exchanges of stock that had been provided for in the stockholders' resolutions just referred to and the exchanges were carried out on or about January 31, 1929. The directors also declared a stock dividend, payable on January 31, 1929, of $ *15 2,500,000, payable in the 6 1/2 percent preferred shares of the company, pro rata, to the holders of common shares.
On January 31, 1929, pursuant to the resolution, 25,000 shares of the 6 1/2 percent preferred stock were issued to the common stockholders of petitioner, pro rata. The preferred stockholders who previously held the 8 percent preferred shares exchanged their 8 percent preferred shares for the new 6 1/2 percent preferred stock, share for share.
On January 31, 1929, immediately prior to the payment of the last mentioned stock dividend, the earnings and profits of petitioner accumulated and undistributed since February 28, 1913 (in addition to earnings and profits represented by the charge of $ 1,000,000 for the stock dividends of 1924) were substantially in excess of $ 2,500,000. When the 25,000 shares of 6 1/2 percent preferred stock were issued as a stock dividend, the earned surplus account was charged on the books *295 of the corporation with the sum of $ 2,500,000 and the capital account was increased in the same amount.
During the period from January 31, 1929, to January 31, 1936, petitioner retired 23,000 shares of the 35,000 shares of 6 1/2 percent preferred*16 stock theretofore issued as stock dividends. The 23,000 shares of 6 1/2 percent preferred stock were retired by the payment to the holders thereof of the call price thereof in cash, namely, $ 110 per share. The par value of the 23,000 shares of 6 1/2 percent preferred stock retired during the period, aggregating $ 2,300,000, was, on the retirement thereof, charged on the books of the company to its capital account.
On January 31, 1936, petitioner had outstanding 12,000 shares of 6 1/2 percent, $ 100 par preferred stock, all of which had been issued as stock dividends, as hereinbefore set forth.
During the fiscal year ended January 31, 1937, petitioner distributed to the owners of its remaining 12,000 shares of 6 1/2 percent preferred stock the sum of $ 1,320,000 in cash, this sum being the call price of the stock at the rate of $ 110 per share. These 12,000 shares of preferred stock were retired and canceled during this year.
Of the 12,000 shares of 6 1/2 percent preferred stock retired in the fiscal year ending January 31, 1937, 6,000 shares were retired on May 1, 1936, and the remaining 6,000 shares on or before October 24, 1936. Upon the retirement of the 12,000 shares of 6*17 1/2 percent preferred stock, the aggregate par value thereof ($ 1,200,000) was charged on the books of the company to the capital account.
Immediately prior to the distributions to petitioner's preferred stockholders of the sums aggregating $ 1,320,000 in retirement of the stock, the earnings and profits of petitioner accumulated and undistributed since February 28, 1913, were substantially in excess of the amounts distributed in liquidation.
Between July 1, 1924, and October 24, 1936, the earnings and profits of petitioner accumulated and undistributed since February 28, 1913, were at all times in excess of the call price of the outstanding preferred shares of petitioner.
Immediately prior to the retirement of the 6 1/2 percent preferred stock, this stock was owned by 433 different owners of record, the great majority of whom were individuals, all residing within the United States, and the largest number of shares of record in the name of any one stockholder was 150.
In the year 1929 the owners sold their 6 1/2 percent preferred shares in petitioner to bankers who offered them to the public in that year at $ 104 a share and accrued dividends. Thereafter these shares were bought *18 and sold on the market, as unlisted shares. The high and low *296 dollar selling prices, for the years 1929 to 1936, inclusive, for the shares were as follows:
| Year | High | Low |
| 1929 | 100 | 94 |
| 1930 | 99 | 92 |
| 1931 | 100 | 91 7/8 |
| 1932 | 86 1/2 | 80 |
| 1933 | 98 | 85 |
| 1934 | 106 1/2 | 98 |
| 1935 | 111 3/4 | 110 1/4 |
| 1936 | Retired at 110 | |
| October 24, 1936. |
Thirty-four of the preferred shareholders of record whose stock was retired in 1936, representing 741 shares of the stock, acquired their shares of record on or after January 1, 1935, and the balance of them (399 different owners of record, representing 11.259 shares) acquired their shares of record between January 31, 1929, and December 31, 1934 inclusive.
On August 24, 1936, the petitioner issued for $ 3,000,000 in cash to the Federated Department Stores, Inc., a Delaware corporation, 30,000 shares of new 4 3/4 percent preferred stock having a par value of $ 100 per share. At that time the Federated Department Stores, Inc., owned 365,401 shares of the common stock of petitioner, out of 370,000 shares outstanding. The Federated Department Stores, Inc., did not own, directly or indirectly, any of the*19 6 1/2 percent preferred stock of petitioner. It did not sell or offer to sell or exchange any of the 4 3/4 percent preferred stock of petitioner acquired by it to any of the holders of 6 1/2 percent preferred stock of petitioner. These holders did not have any option to exchange their stock or do other than take cash for it.
On May 1, 1936, petitioner borrowed $ 600,000 from the First National Bank of Chicago on several notes at rates of interest varying from 1 1/4 percent to 2 1/4 percent. The proceeds of this loan were used in part payment for the 6 1/2 percent preferred stock retired on May 1, 1936.
Part of the proceeds of the $ 3,000,000 for the 4 3/4 percent preferred stock was used to retire the 6,000 shares of 6 1/2 percent preferred stock of petitioner, retired pursuant to a resolution of August 20, 1936, and also to pay off the notes payable to the First National Bank of Chicago.
In computing the dividend paid credit deductible in determining the undistributed net income subject to undistributed profits surtaxes for the fiscal year ending January 31, 1937, the petitioner on its return deducted as such credit the sum of $ 1,200,828.13, as follows:
| Cash dividends | $ 711,053.56 |
| Paid in cash in partial liquidation and in redemption and | |
| retirement of 12,000 shares of 6 1/2% preferred stock | 1,320,000.00 |
| Total | 2,031,053.56 |
| Dividends paid credit, item 29, page 1 of return | $ 1,200,828.13 |
| Dividend carry-over | 830,225.43 |
*20 *297 The Commissioner disallowed the deduction of the $ 1,320,000 paid in partial liquidation and in redemption and retirement of 12,000 shares of 6 1/2 percent preferred stock.
In computing the dividend paid credit deductible in determining the undistributed net income subject to undistributed profits surtaxes for the fiscal year ending January 31, 1938, the petitioner, on its return, deducted as such credit the sum of $ 1,342,725.43, as follows:
| Cash dividends | $ 512,500.00 |
| Dividend carry-over credit (as shown above) | 830,225.43 |
| Total | 1,342,725.43 |
The Commissioner disallowed the deduction of $ 830,225.43 as a dividend carry-over credit.
In addition to the stipulated facts, we find the following:
The history of petitioner's capital account from the date of its organization until July 1, 1924, shows:
| Stock | |||
| Date | Stock issued | Amount | canceled |
| July 31, 1907 | Capital stock | $ 200,000 | |
| May 1908 | Capital stock (stock dividend) | 100,000 | |
| May 1910 | 4% preferred (issued for cash) | 250,000 | |
| At Feb. 28, 1913 | 550,000 | ||
| July 6, 1914 | 4% preferred (issued for cash) | 200,000 | |
| March 7, 1917 | 5% preferred (all preferred made | 50,000 | |
| 5% at this time (issued for cash). | |||
| Sept. 29, 1919 | Common (stock issued for notes) | 700,000 | |
| Nov. 20, 1922 | Common (stock dividend) | 1,000,000 | |
| Jan. 31, 1924 | Canceled preferred by paying cash | ||
| therefor | $ 500,000 |
*21 The amounts of the stock dividends issued in 1908 and 1922 were deducted from petitioner's surplus account and added to its capital account.
As computed by petitioner on its income and excess profits tax return, the dividends paid by petitioner during the fiscal year ending January 31, 1937, exceeded the adjusted net income for such year by the sum of $ 830,225.43. The income and excess profits tax return for the fiscal year ending January 31, 1938, showed petitioner's adjusted net income to be $ 1,062,640.75. From this sum petitioner deducted cash dividends paid of $ 512,500 and the dividends carry-over credit of $ 830,225.43, totaling $ 1,342,725.43.
OPINION.
The first issue presented is whether petitioner is entitled to a dividends paid credit under section 27 (f) of the Revenue *298 Act of 1936, 1 for its fiscal year ending January 31, 1937, by reason of the retirement of preferred stock. Petitioner contends that it is entitled to such a credit because the retired stock had, in previous years, been issued as stock dividends and represented earnings and profits accumulated after February 28, 1913. It argues that the retirement of this stock resulted in a distribution *22 of those accumulated earnings and profits. Respondent, on the other hand, takes the position that the stock dividends had the effect of turning the earnings and profits into capital. Therefore, he insists, the retirement of this stock was a return of capital for which no dividends paid credit can be allowed.
Section 27 (f) sets up two requirements before a dividends paid credit may be allowed. First, there must be a distribution in liquidation, and, second, the distribution must be properly chargeable to earnings and profits accumulated after February 28, 1913. Respondent does not contest that there has been a distribution in liquidation*23 in this proceeding within the meaning of section 27 (f). Section 115 (i) of the Revenue Act of 1936 defines a partial liquidation to include "a distribution by a corporation in complete cancellation or redemption of a part of its stock." Here the distribution by petitioner during the year ending January 31, 1937, resulted in the complete cancellation or redemption of its preferred stock which had been issued as stock dividends. Such a distribution constitutes a distribution in liquidation. Hill v. Commissioner, 126 Fed. (2d) 570. The first requirement of section 27 (f), that the distribution must be in liquidation, has been met.
The next question is whether the distribution was properly chargeable to earnings and profits accumulated after February 28, 1913. The record shows that the earnings and profits were accumulated after February 28, 1913, and thus there is left only the problem whether the distribution was properly chargeable to earnings and profits. Petitioner in 1924 and 1929 capitalized its earnings and profits by issuing preferred stock dividends. Those dividends were nontaxable under the statutes effective when the dividends were*24 issued. 2Helvering v. Gowran, 302 U.S. 238">302 U.S. 238. On its books petitioner reduced its earned surplus account and increased its capital account by the amount of the par value of stock issued as dividends. From 1929 to 1936 petitioner retired all of this stock except 12,000 shares. On May 1, 1936, petitioner retired 6,000 of these shares, using the proceeds of a loan effected on that date in part payment therefor. On August 24, 1936, petitioner issued 30,000 shares of 4 3/4 percent preferred stock with a par *299 value of $ 100 for $ 3,000,000 in cash, to a corporation which owned practically all of its common stock. It used the proceeds of this issue to retire the remaining 6,000 shares of stock which had been issued as a stock dividend.
As we see it, the crux of the problem is whether a capitalization of earnings prevents*25 those earnings from being distributed as taxable dividends. Respondent's argument centers around the theory that earnings once capitalized are like money paid in as capital, which is never available for dividends. We disagree with this view in the light of section 115 (h) of the Revenue Act of 1936. 3 Referring to this section, the Senate Committee on Finance, in its report on the Revenue Act of 1936, made this statement:
The rule, under existing law, with respect to the effect on corporate earnings or profits of a distribution which, under the applicable tax law, is a nontaxable stock dividend or a distribution of stock or securities in connection with a reorganization or other exchange, on which gain is not recognized in full, is that such earnings or profits are not diminished by such distribution. In such cases, earnings or profits remain intact and hence available for distribution as dividends by the corporation making such distribution, or by another corporation to which the earnings or profits are transferred upon such reorganization or other exchange. This rule is stated only in part in section 115 (h) of the Revenue Act of 1934, and corresponding provisions of prior*26 acts, but is the rule which is applied by the Treasury and supported by the courts in Commissioner v. Sansome, 60 Fed. (2d) 931; U. S. v. Kauffman, 62 Fed. (2d) 1045; Murcheson v. Comm., 76 Fed. (2d) 641. While making no change in the rule as applied under existing law, the recommended amendment is desirable in the interest of greater clarity.
As the above quotation indicates, the earnings and profits in the case at bar remained intact after the stock dividends were issued and hence were available for the payment of dividends.
*27 We regard as immaterial the fact that petitioner issued other preferred stock in 1936 to obtain the funds necessary to retire the preferred stock which had been issued as a dividend. James Irvine, 46 B. T. A. 246.
Although the earnings and profits remained intact after the issuance of a stock dividend, it does not follow as petitioner contends, that the retirement of the stock was entirely chargeable against surplus. In this respect we reaffirm our holding in August Horrmann, 34 B. T. A. 1178, *300 which concerned the taxability to stockholders of a cash distribution by a corporation in 1930. In dealing with the effect which a distribution in 1927 by the corporation in redemption of preferred stock previously issued as a dividend had upon the remaining earnings and profits of the corporation available for subsequent distribution, the Board stated:
* * * We are unwilling to disregard the interest which shares of stock represent in the assets of the corporation and to say that they serve only to earmark a portion of surplus. Also, we are unwilling to attempt to earmark shares of stock and say that the redemption *28 of the original shares is entirely chargeable against capital account (to the extent of the amount originally paid in) while the redemption of dividend shares is chargeable in no part against capital. We think that a proportional part of the paid-in capital must be considered as standing behind each of the shares outstanding at any particular time, so that on redemption of any of them a certain part of the redemption is properly chargeable against capital account. Since the capital structure as distinguished from the statutory "capital account" was increased to $ 1,000,000 by the issuance of new stock of the par value of $ 600,000 in 1922, while the paid-in capital (the statutory capital account) remained at $ 400,000, we think that the 1927 redemption should be chargeable against capital account in the ratio of $ 400,000 to $ 1,000,000.
In the case at bar the history of petitioner's capital account shows that prior to 1924 $ 1,400,000 in property was actually paid into the capital account by stockholders. In addition petitioner in 1908 capitalized $ 100,000 of its surplus by a declaration of a stock dividend. We must treat the latter amount as though it were paid-in capital, as*29 pre-1913 earnings are not subject to income tax. Foster v. United States, 303 U.S. 118">303 U.S. 118. Thus we shall consider the paid-in capital prior to 1924 as being $ 1,500,000. In 1922 petitioner capitalized $ 1,000,000 of its earned surplus by a stock dividend, thereby increasing its capital structure to $ 2,500,000. On January 31, 1924, petitioner canceled preferred stock in the amount of $ 500,000. Since $ 1,500,000 of the total capital structure was paid-in capital, three-fifths of the $ 500,000, or $ 300,000, paid to cancel the preferred stock represented paid-in capital. Thus the paid-in capital was reduced by that transaction to $ 1,200,000. On June 30, 1924, petitioner issued a preferred stock dividend of 10,000 shares and had outstanding 20,000 shares of common stock. The paid-in capital standing behind each share, then, was $ 40, computed by dividing $ 1,200,000, the paid-in capital, by 30,000, the total number of shares outstanding. In 1927 petitioner canceled 7,000 shares of common stock, thus reducing the paid-in capital by $ 280,000, leaving a remainder of $ 920,000. The paid-in capital remained at the latter figure when the preferred*30 stock dividend of 25,000 shares was issued in 1929. The 1929 stock dividend increased the number of shares outstanding to 48,000. We regard as immaterial for our purposes the exchange in 1929 of the outstanding 13,000 shares of $ 100 par value common stock for 350,000 shares of new no par value common stock, because the paid-in capital standing behind the 350,000 shares *301 when issued remained the same as that which had stood behind the old 13,000 shares. Therefore, we base our computations on 13,000 shares of common stock and 35,000 shares of preferred stock outstanding. The paid-in capital standing behind each share of stock after the 1929 preferred stock dividend was $ 19.16+ computed by dividing $ 920,000, the total paid-in capital, by $ 48,000, the total number of shares outstanding.
From January 31, 1929, to January 31, 1936, petitioner retired 23,000 of the 35,000 shares of its outstanding preferred stock, thereby reducing the paid-in capital by $ 440,818.20, leaving a remainder of $ 479,166.80. Immediately thereafter the paid-in capital standing behind each share of the remaining 25,000 shares of outstanding stock was $ 19.16+, computed by dividing $ 479,166.80, *31 the total remaining paid-in capital, by 25,000, the total number of shares outstanding. On May 1, 1936, petitioner retired 6,000 shares of preferred stock. Since $ 19.16+ per share paid to retire this stock represented paid-in capital, petitioner is entitled to a dividends paid credit for the taxable year ending January 31, 1937, for all amounts in excess of that sum. The retirement of those 6,000 shares reduced the total paid-in capital to $ 364,166.84, and the total number of shares outstanding to 19,000.
On August 24, 1936, petitioner issued 30,000 shares of additional preferred stock having a par value of $ 100 per share for $ 3,000,000 in cash. This increased the total number of shares outstanding to 49,000 and the total paid-in capital to $ 3,364,166.84. Thus the paid-in capital standing behind each share of the 6,000 shares of preferred stock retired between August 24 and October 24, 1936, was $ 68.65+, computed by dividing $ 3,364,166.84, the total paid-in capital, by 49,000, the total number of shares outstanding at that time. Petitioner, therefore, is also entitled to a dividends paid credit for the taxable year ending January 31, 1937, for all amounts paid to retire*32 the latter 6,000 shares in excess of $ 68.65+ per share.
The premium of $ 10 a share which petitioner paid over and above the par value of the retired stock should be included in the dividends paid credit. J. Weingarten, Inc., 44 B. T. A. 798.
The second issue presented to this Court is whether petitioner is entitled to a dividends carry-over credit for the year ending January 31, 1938, under section 27 (b) (2) of the Revenue Act of 1936. 4 Respondent *302 does not contest this issue. It seems clear that petitioner is entitled to this credit, since apparently the dividends paid during the year ending January 31, 1938, were less than the adjusted net income for that year, and the dividends paid in the year ending January 31, 1937, were greater than the adjusted net income for that year. Thus the requirements of section 27 (b) (2) are met. This carry over credit should be limited to the amount by which the cash dividends plus the dividends paid in retiring stock, computed as directed under the first issue, exceed the adjusted net income for the year ending January 31, 1937.
*33 Decision will be entered under Rule 50.
Footnotes
1. SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
* * * *
(f) Distributions in Liquidation. -- In the case of amounts distributed in liquidation the part of such distribution which is properly chargeable to the earnings or profits accumulated after February 28, 1913, shall, for the purposes of computing the dividends paid credit under this section, be treated as a taxable dividend paid.↩
2. Section 201 (f) of the Revenue Act of 1924 and sec. 115 (f)↩ of the Revenue Act of 1928 both provided: "* * * a stock dividend shall not be subject to tax."
3. SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
* * * *
(h) Effect on Earnings and Profits of Distributions of Stock. -- The distribution (whether before January 1, 1936, or on or after such date) to a distributee by or on behalf of a corporation of its stock or securities or stock or securities in another corporation shall not be considered a distribution of earnings or profits of any corporation --
(1) if no gain to such distributee from the receipt of such stock or securities was recognized by law, or
(2) if the distribution was not subject to tax in the hands of such distributee because it did not constitute income to him within the meaning of the Sixteenth Amendment to the Constitution↩ or because exempt to him under secion 115 (f) of the Revenue Act of 1934 or a corresponding provision of a prior Revenue Act.
As used in this subsection the term "stock or securities" includes rights to acquire stock or securities.4. SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
* * * *
(b) Dividend Carry-Over. -- In computing the dividends paid credit for any taxable year, if the dividends paid during the taxable year are less than the adjusted net income, there shall be allowed as part of the dividends paid credit, and in the following order:
* * * *
(2) Dividends paid during the first preceding taxable year in excess of the adjusted net income for such year.
No credit shall be allowed for dividends paid by a corporation prior to its first taxable year under this title.↩