*1867 Held that petitioner has failed to prove the amount of stock, if any, which he claimed he was compelled to surrender to other stockholders without consideration, and that he has thus failed to prove that he sustained a deductible loss.
*496 This is a proceeding for the redetermination of a deficiency in income tax for the year 1925 in the amount of $5,943.47, arising from the disallowance by the respondent of a claimed deduction in the amount of $30,000. The petitioner alleges that the respondent erred in failing to allow this claimed deduction from gross income in the year 1925 as a loss suffered by the petitioner in a stock transaction in that year.
FINDINGS OF FACT.
The petitioner is an individual and a resident of East Port Chester. Conn.
In 1912 petitioner caused to be incorporated under the laws of New York the Electric Heating Apparatus Company, hereinafter called the Electric Company. He supplied all the machinery and all the patents and he and his son, Walter, managed the business.
When the Electric Company was incorporated, *1868 petitioner operated the business as if it were his individual business. Later his sons, Walter and A. O. Eimer, and his daughter paid in money and then received shares of the stock.
From June 15, 1916, to August 22, 1924, the petitioner advanced to the Electric Company an amount of $199,505.22, for which the company gave its promissory notes. None of these notes, with the exception of one on which $600 was paid, was ever paid. From about 1914 or 1915, Edwin L. Smalley was vice president and manager of the company. The petitioner was the president of the company.
On October 14, 1924, the Electric Company, in order to obtain working capital from the Milwaukee Light, Heat & Traction Company, entered into a contract with that company whereby it agreed to enter into an agency agreement with the North American Company, of which the Milwaukee Light, Heat & Traction Company was a subsidiary. In such agreement it also agreed to reorganize, by *497 amendment of its charter or by creating a new corporation so as to recapitalize the electric company, as follows:
* * *
(a) Issuance of Five Hundred Thousand Dollars ($500,000) common stock consisting of Five Thousand (5000) *1869 shares of One Hundred Dollars ($100) par value each, retaining all of its present assets.
(b) Retirement of present Fifty Thousand Dollars ($50,000) of Preferred stock and Twenty Thousand ($20,000) of common stock constituting the entire outstanding capital stock of the Company.
(3) To pay all notes now payable to August Eimer, with the new common stock.
It was to deposit with the Milwaukee Company shares of stock and the Milwaukee Company was to loan it a maximum of $150,000 to be secured by the stock as collateral.
In compliance with the terms of the above contract the Electric Company, on the same date, entered into an agency agreement with the North American Company.
At the time these agreements were entered into the stock of the Electric Company was owned as follows:
| Stockholders | Shares of preferred stock | Shares of common stock |
| August Eimer | 200 | 170 |
| A. O. Eimer | 100 | 10 |
| Walter R. Eimer | 100 | 10 |
| Elsa Eimer | 100 | 0 |
| Edwin L. Smalley | 0 | 10 |
| Total | 500 | 200 |
On that same date, October 14, 1924, an agreement was made between Smalley, A. O. Eimer and the petitioner, which, after reciting the fact that the two contracts mentioned above and been*1870 entered into, provided that a new corporation should be formed and named the Hevi-Duty Electric Company, and that it was to have a capital stock of 5,000 shares, of which Edwin L. Smalley was to receive 750 shares, A. O. Eimer 390 shares, and the petitioner 3,050 shares, and the remaining shares were to be distributed as provided for theretofore by certain other agreements. The contract further provided that, when the petitioner had received cash to the amount of $305,000, in the form of dividends or other earnings from the stock, he would then transfer all his title in the aforesaid 3,050 shares of the stock to Smalley and A. O. Eimer in the following manner: 1,345 shares to Smalley and 1,705 shares to A. O. Eimer, so that A. O. Eimer and Smalley would have an equal number of shares. These parties and the other stockholders entered into a voting-trust agreement on the same date, whereby the petitioner, as trustee, was given one right to vote the stock.
*498 Smalley was president and director of the new corporation, Hevi-Duty Electric Company, and A. O. Eimer was treasurer.
The Hevi-Duty Electric Company expended large sums for equipment and experimentation and used*1871 up all of the $150,000 loaned to it by the Milwaukee Company. There were a number of conferences with representatives of the Milwaukee Company in regard to an additional loan in July or August, 1925. Petitioner's son, A. O. Eimer, had died and Smalley was threatening to leave for a better position unless the petitioner would turn over additional stock to him.
An agreement was entered into on August 5, 1925, by the petitioner, June P. Eimer, widow of A. O. Eimer, Edwin L. Smalley and the executors of the estate of A. O. Eimer, which provided as follows:
WHEREAS, there is now issued and outstanding five thousand (5,000) shares of the capital stock of Hevi-Duty Electric Company hereinafter called "The Company," being the entire authorized capital stock of said Company; and
* * *
WHEREAS, the said capital stock of the Company is about to be delivered up and cancelled and new stock to be issued in lieu thereof as follows:
Twenty-five hundred (2500) shares of the par value of $100 each of nonvoting stock entitled to receive non-cumulative dividends at the rate of 6% per annum, to be known as Class A stock, and twenty-five hundred (2500) shares of voting stock of no par value, *1872 to be known as Class B stock, the earnings of the Company after the payment of the non-cumulative 6% dividend upon the Class A stock as aforesaid, to be used for the redemption and retirement of said Class A stock; and
WHEREAS, all of Class A stock as aforesaid is to be issued to August Eimer and said Class B stock is to be issued as follows:
Twelve hundred and fifty (1250) shares to said August Eimer and twelve hundred and fifty (1250) shares to Milwaukee Light, Heat & Traction Company; and
WHEREAS, said August Eimer is voting trustee under a voting trust agreement dated October 14th, 1924, whereby said Edwin L. Smalley deposited seven hundred and fifty (750) shares of the capital stock of the Company and receiving a voting trust certificate from said August Eimer for a like amount, and whereby A. O. Eimer deposited three hundred and ninety (390) shares of said capital stock and received a voting trust certificate for a like amount, said voting trust to terminate at such time as the shares of stock of the Hevi-Duty Electric, company pledged as collateral with Milwaukee, Light, Heat & Traction Company should be returned to the trustee; and
* * *
1. The Executors, said June*1873 P. Eimer and said Edwin L. Smalley hereby severally release and discharge said August Eimer of and from, any and all obligations arising under, or cause or causes of action upon said agreement dated October 14, 1924, as aforesaid.
2. Said Executors, said June P. Eimer and said Edwin L. Smalley hereby surrender to the said August Eimer as trustee, the said voting trust certificates heretofore mentioned, the receipt whereof by said trustee is hereby acknowledged, and do hereby release and transfer to said August Eimer, individually, *499 all right, title and interest of the said Executors and the said June P. Eimer to the three hundred and ninety shares (390) of stock represented by said voting trust certificate heretofore issued to A. O. Eimer and to the seven hundred and fifty (750) shares of stock represented by said voting trust certificate heretofore issued to the said Edwin L. Smalley, and do release and discharge the said August Eimer from any and all obligation or obligations arising under said agreement or certificates or cause or causes of action arising thereon and do consent to the immediate cancellation of said voting trust agreement.
3. Said August Eimer*1874 covenants and agrees that when the Company shall issue the said Class A stock, he will immediately transfer and assign to Edwin L. Smalley six hundred and twenty-five (625) shares and to the Executors six hundred and twenty-five (625) shares of said Class A stock.
4. Said August Eimer agrees that when the Company shall issue the said Class B Stock he will immediately transfer and assign to Edwin L. Smalley four hundred and sixteen and two-thirds (416 2/3) shares and to the Eexecutors four hundred and sixteen and two-thirds (416 2/3) shares of said Class B stock.
5. The Executors and the said June P. Eimer and said Edwin L. Smalley each agree that when said Class A stock mentioned in paragraph 3 shall have been transferred and assigned to them respectively as therein provided, they will pledge said stock to Milwaukee Light, Heat & Traction Company to secure the advances in the sum of Two hundred and fifty thousand dollars ($250,000) made or to be made to the Company by said Milwaukee Light, Heat & Traction Company.
6. The Executors and the said June P. Eimer and said Edwin L. Smalley each agree that when said Class B stock mentioned in paragraph 4 shall have been transferred*1875 and assigned to them respectively as therein provided, they will pledge said stock to Milwaukee, Light, Heat & Traction Company to secure the advances in the sum of Two hundred and fifty Thousand dollars ($250,000) made or to be made to the Company by said Milwaukee Light, Heat & Traction Company.
* * *
The contract further provided that all the stock should be delivered to the petitioner as voting trustee and that he might pledge such stock to the Milwaukee Light, Heat & Traction Company to secure advances made by that company not to exceed $250,000.
All of the aforementioned agreements were carried out according to their terms except those which were specifically canceled by a succeeding agreement.
On August 14, 1925, the petitioner wrote a letter to the Milwaukee Light, Heat & Traction Company which was accepted by them, the material part of which is as follows:
I own or control the entire issued and outstanding capital stock of Hevi Duty Electric Company, a Wisconsin corporation (hereinafter called the "Hevi Duty Company"), consisting of 5,000 shares, all of one class, of the par value of $100 a share. Your Company has heretofore loaned the Hevi-duty Company and its*1876 predecessor company amounts aggregating $150,000 and you now hold the promissory notes of the Hevi Duty Company and the *500 notes of its predecessor which have been heretofore assumed by the Hevi Duty Company, payable as follows:
$35,000 on October 21, 1927
15,000 on November 25, 1927
2,500 on January 8, 1928
22,500 on January 15, 1928
15,000 on April 23, 1928
10,000 on April 30, 1928
40,000 on May 29, 1928
10,000 on July 6, 1928
These notes are secured by the pledge of $240,000 par amount of the outstanding stock of the Hevi Duty Company.
This letter is to confirm our understanding that you will lend an additional $100,000 to the Hevi Duty Company upon the following terms:
(1) I shall cause the Hevi Duty Company to be recapitalized, so that it will have an authorized and outstanding capital stock consisting of 2,500 shares of Class A stock, of the par value of $100 a share, and 2,500 shares of Class B Stock without par value. The shares of each class are to be entitled to the relative rights, privileges and preferences and are to be subject to the relative restrictions and qualifications set forth in Schedule A, attached hereto, with only such changes*1877 and modifications therein as your counsel and my counsel may agree upon for the purpose of conforming to the Laws of Wisconsin.
(2) Upon the completion of this recapitalization of the Hevi Duty Company, you will lend the Hevi Duty Company an additional $100,000 payable on August 1, 1928 and you will extend to August 1, 1928 the term of the present indebtedness of the Hevi Duty Company to you, in the amount of $150,000. The Hevi Duty Company will issue and deliver to you, in the denomination of $25,000 each, its promissory notes payable August 1, 1928, in the aggregate fact amount of $250,000, bearing interest at the rate of 6% per annum, payable semi-annually, from the date of issue until paid, The notes will provide that the Hevi Duty Company shall have the right at its election to anticipate payment before maturity at any time in whole or from time to time in part. You will surrender for cancellation the outstanding notes of the Hevi Duty Company now held by you in the aggregate face amount of $150,000; and the Hevi Duty Company will then pay the interest on said outstanding notes to the date of issue of the new notes.
(3) In consideration of your making the foregoing additional*1878 loan to the Hevi Duty Company and extending the term of the outstanding indebtedness of that Company to you, I agree, contemporaneously with you making such loan and extension, to assign and deliver to you, for your own use, 1,250 shares of the Class B Stock of the Hevi Duty Company, without par value, being one-half the amount of the then authorized and outstanding Class B Stock; and I shall also deliver to you in pledge for the security of the $250,000 aggregate face amount of the notes of the Hevi Duty Company then held by you, the entire authorized and outstanding Class A Stock of that Company, of the aggregate par amount of $250,000, and the remaining Class B Stock of that Company consisting of the 1,250 shares without par value to be owned by me and my associates. In case the notes are not paid at maturity, or in case of default in the payment of interest thereon when due, you shall not have the right to foreclose on the said stock of the Hevi Cuty Company pledged with you until after you shall have given me at least thirty days' notice in writing addressed to me in care of Carl B. Eimer, Esq., 170 Broadway, New York City. * * *
* * *
*501 This letter has attached*1879 to it a schedule which provided that the holders of the shares of Class A stock should be entitled to receive out of the profits each year dividends at the rate of 6 per cent per annum before any sums should be set aside for redemption of the stock or for the payment of dividends on the Class B stock and that in the event of any liquidation, dissolution or winding up of the affairs of the corporation, the holders of the Class A stock should be entitled to be paid in cash $100 per share, together with so much of the undivided net profits as should be applicable to the payment of dividends on the Class A stock and not theretofore paid, before any distribution should be made to the holders of the Class B stock; It further provided that the privilege to vote should be wholly vested in the Class B stock and not in the Class A stock.
These agreement were carried out according to their terms.
On his return the petitioner, under deductions authorized by law, claimed the following:
Compensation in lieu of cash to Edwin L. Smalley 1141 shares of Hevi-Duty Electric Company. Same was to induce him to sign the agreement on or about August 4, 1925. The shares cost me at least $30, each. *1880 Total carried out, $30,000.
The Commissioner disallowed this $30,000, in his deficiency letter as a "loss on stock of the Hevi-Duty Electric Company."
OPINION.
MCMAHON: It is claimed by the petitioner that the respondent erred in failing to allow him a deduction from his gross income for the year 1925 on account of the surrender by him of shares of stock of the Hevi-Duty Electric Company to other stockholders. It is claimed by petitioner that he was compelled to surrender shares of stock without any consideration therefor to two other stockholders in order to retain the services as manager and officer of one of said stockholders in the company and to obtain the use of their stock as collateral for a loan to the company.
In his return for the year 1925 the petitioner claimed a deduction in the amount of $30,000, representing 1,141 shares at a valuation of about $30 per share. In his petition, petitioner claims a deduction in the amount of $37,733.33, representing 943 1/3 shares at $40 per share.
The evidence discloses that the Hevi-Duty Electric Company, as it was first organized, had an authorized capital stock of 5,000 shares of the par value of $100 each, of which*1881 petitioner held 3,050 shares, Edwin L. Smalley 750 shares, and A. O. Eimer 390 shares. The company was reorganized in 1925 with a capital stock of 2,500 shares of Class A stock of the par value of $100 each and 2,500 shares of Class B stock of no par value. In the agreement between petitioner, *502 Smalley and executors of the estate of A. O. Eimer, under date of August 5, 1925, under which agreement petitioner claims he was compelled to surrender the stock for which the deduction is claimed, Smalley and the estate of A. O. Eimer were to receive and did each receive 625 shares of Class A stock and 416 1/3 shares of Class B stock. It will be noted from the schedule attached to letter of petitioner under date of August 14, 1925, that Class A stock was preferred as to dividends and in the distribution of assets upon dissolution of the company.
In his brief petitioner shows that the 943 1/3 shares of stock which he claims in his brief were surrendered are the difference between 1,140 shares, the amount of stock Smalley and A. O. Eimer held in the old corporation, and 2,083 1/3 shares, the amount which Smalley and the estate of A. O. Eimer received in the reorganized corporation. *1882 While there is no evidence as to the amount and/or class of stock of the newly organized company which the stockholders were to receive as a matter of right in lieu of the stock of the old company, we deem it reasonable to assume that each stockholder was entitled to receive as a matter of right the same percentage of Class A stock and Class B stock, after deducting 1,250 shares thereof which it was agreed should be transferred to the Milwaukee Light, Heat & Traction Company, as each held in the old company. However, we find that the parties did not receive each class of new stock in these proportions, and since there is no evidence to show the relative value of the two classes of new stock, we can not determine the loss, if any, which petitioner sustained.
Furthermore, from the contract of August 5, 1925, it will be seen that the transfer of stock thereunder to Smalley and the estate of A. O. Eimer was, at least in part, in consideration of the release of petitioner from the terms of the contract of October 14, 1924, under which petitioner was required to transfer his 3,050 shares of stock to Smalley and A. O. Eimer at such time as his receipts in the form of dividends or other*1883 earnings from said stock should have reached the sum of $305,000. Thus, at least, an undisclosed portion of whatever stock petitioner surrendered to those stockholders was in the nature of a capital expenditure, being an additional cost to petitioner of the shares which he retained. The surrender of stock for this purpose does not give rise to a deductible loss. Since we are without evidence to determine how much of the stock, if any, petitioner was forced to surrender to Smalley and the estate of A. O. Eimer, without consideration, we could not fix the amount of loss which petitioner is entitled to deduct, if any, even if we knew the value of the total amount of stock petitioner surrendered. We must approve the determination of the respondent.
Judgment will be entered for the respondent.