*1004 Where a plan involved an exchange by one corporation of assets in the form of accounts receivable for all the stock in another corporation, for the purpose of preserving the credit of the transferor, held, although the tax consequences of the plan in which the exchange occurred were considered, such exchange was "in pursuance of a plan of reorganization" within the meaning of the Revenue Act of 1928, section 112(i)(1)(B) and section 112(g), and that the distribution of that stock by the transferor to its shareholders, pro rated to their holdings in its stock and without their surrender thereof, is not taxable to its recipients. Sec. 112(g), supra.
*648 These consolidated proceedings seek redetermination of deficiencines in income taxes for the calendar year 1931. Docket No. 75993 involves a deficiency of $32,166.68 against the estate of Walter C. Bailey, and an alleged overpayment of tax for that year of $5,781.25. Docket No. 75994 involves a deficiency against the decedent's wife, *1005 Bertha M. Bailey, in the amount of $33,350.35.
FINDINGS OF FACT.
The petitioners, Bertha M. Bailey and Walter C. Bailey, Jr., are individuals residing at Wyncote, Pennsylvania, and are the duly qualified executors of the estate of Walter C. Bailey, who died May 26, 1933. The tax returns for the year in controversy were made to the collector of internal revenue for the first district of Pennsylvania.
The Reyburn Manufacturing Co., hereinafter called the Manufacturing Co., is a Pennsylvania corporation. It was organized in 1895 and has since then been engaged in the manufacture and sale of paper tags, labels, and other paper products. During the year 1931, and for several years prior thereto, the late Walter C. Bailey was president and a director of that company, and with his wife, Bertha M. Bailey, owned, by entireties, 6,146 shares out of a total of 6,239 shares of stock of the company issued and outstanding.
Among the assets of the Manufacturing Co. in 1931 were certain notes receivable of a face value of $365,000, due by the late Walter C. Bailey for moneys borrowed by him from the company from time to time for the purpose of carrying on certain real estate transactions*1006 in which he was individually engaged. The Manufacturing Co. carried on its banking business with the Corn Exchange National Bank & Trust Co. of Philadelphia, with which it then had loans aggregating $80,000. During the year 1931, the large amount of the borrowings by the late Walter C. Bailey from the Manufacturing Co. came to the attention of the officers of this bank. As a result, Bailey was called in and advised by the bank that it disapproved of these loans and if that condition were not cleared up it would call its outstanding loans to the Manufacturing Co. and deny the latter further credit.
*649 Upon receiving this advice, the late Walter C. Bailey advised his attorney of the demand made by the bank and asked his counsel as to the best method of meeting the situation. The funds borrowed by Bailey from the Manufacturing Co. had been used largely by him in the acquisition of a property located in Camden, New Jersey, and known as the Broadway Federal Building. This property consisted of a store and office building. It had a cost to Bailey of $318,750, and was encumbered by mortgages in the sum of $750,000. The question of a transfer of this property by Bailey to*1007 the Manufacturing Co. in satisfaction of the loan indebtedness was discussed and Bailey's attorney pointed out that the property was located in another state and that it was his opinion, in view of the limitation of the business of the Manufacturing Co. by its charter to the manufacture, distribution, and sale of shipping tags, envelopes, and other paper products, it was doubtful whether it had corporate authority to acquire the New Jersey property. His attorney advised that, in his opinion, the best plan would be the creation of a new corporation having corporate power to own and operate the Camden property and the transfer to this corporation by the Manufacturing Co. of the Bailey notes, and then the transfer of the Camden property to this new corporation, thus segregating in one competent corporation the New jersey building and the notes with the proceeds of which Bailey purchased the property.
Accordingly, in November 1931, a New Jersey corporation known as the Reyburn Corporation was organized with an authorized issue of 3,250 shares of stock of no par value. Of this stock, the Manufacturing Co. subscribed to 10 shares at a cost of $112.50 per share. Thereupon, the Manufacturing*1008 Co. and the Reyburn Corporation, both acting with authority of their directors, entered into a contract providing that the latter company would acquire from the former the $365,000 in notes receivable due from Walter C. Bailey in exchange for 3,240 shares of its capital stock, which, together with the 10 shares subscribed for which the Manufacturing Co. had paid cash, were to be distributed to the stockholders of the latter company in proportion to their holdings of Manufacturing Co. stock and without surrender of such stock by the latter.
In accordance with this agreement the Manufacturing Co. transferred to Reyburn Corporation the notes receivable in the aggregate amount of $365,000, together with $1,125 in cash, and the Reyburn Corporation thereupon distributed to the stockholders of the Manufacturing Co. 3,250 shares, being all of its authorized capital stock. This distribution of the stock of Reyburn Corporation to the stockholders of the Manufacturing Co. was in proportion to their stockholdings in the Manufacturing Co. and without surrender by them *650 of any of their shares of the Manufacturing Co. stock. The late Walter C. Bailey and his wife, petitioner Bertha*1009 M. Bailey, virtue of their ownership as tenants by entireties of 6,146 shares of Manufacturing Co. stock, received 3,001.6 shares of Reyburn Corporation stock thus distributed.
On January 1, 1931, and December 31, 1931, the earned surplus of the Manufacturing Co. was $1,182,638.04 and $871,465.60, respectively. The net income of that corporation for the calendar year 1931 was $143,141.33. The comparative balance sheets of the corporation as of December 31, 1930, and December 31, 1931, are as follows:
| 1930 | 1931 | |
| ASSETS | ||
| Current assets: | ||
| Cash | $81,318.66 | $81,395.00 |
| Notes receivable | 315,000.00 | |
| Accounts receivable - customers | 190,097.75 | 158,924.48 |
| Less: Reserve for doubtful accounts | -5,480.25 | -5,480.25 |
| Accounts receivable - miscellaneous | 6,499.08 | |
| Inventories | 368,956.65 | 328,011.90 |
| Total current assets | 949,892.81 | 569,350.21 |
| Investment (first mortgage bonds) | 50,000.00 | 50,000.00 |
| Mortgage receivable | ||
| Real estate, building and equipment: | ||
| Land | 151,863.20 | 139,626.63 |
| Buildings | 714,500.60 | 716,040.20 |
| Machinery and equipment | 564,881.50 | 584,582.33 |
| Improvements | 5,176.51 | 5,176.51 |
| 1,436,421.81 | 1,445,425.67 | |
| Less: Reserve for depreciation | 362,275.52 | 413,609.92 |
| 1,074,146.29 | 1,031,815.75 | |
| Deferred charges to operations | 14,793.63 | 12,711.56 |
| 2,088,832.73 | 1,663.877.52 | |
| LIABILITIES | ||
| Current liabilities: | ||
| Notes payable | 220,000.00 | 155,000.00 |
| Accounts payable: | ||
| Vendors | 31,427.47 | 15,759.53 |
| Miscellaneous | 1,560.72 | 1,125.00 |
| Commissions payable | 1,139.41 | |
| Accrued - wages | 3,720.85 | 3,924.85 |
| Do. - interest | 4,932.29 | 4,500.00 |
| Due officers and employees | 7,004.65 | 8,719.12 |
| Reserve for federal income tax | 11,629.30 | 17,596.74 |
| Prepaid rent | 1,006.68 | |
| Deposit - under purchase agreement | 10,000.00 | |
| Total current liabilities | 281,414.69 | 217,631.92 |
| Mortgage payable | 500,000.00 | 450,000.00 |
| Capital: | ||
| Capital stock outstanding (6,239 shares) | 124,780.00 | 124,780.00 |
| Earned surplus | 1,182,638.04 | 871,465.60 |
| Reserve for future taxes | ||
| 1,307,418.04 | 996,245.60 | |
| 2,088,832.73 | 1,663,877.52 |
*1010 Following the transfer of the notes and cash to the Reyburn Corporation by the Manufacturing Co. on or about December 17, 1931, as hereinbefore detailed, and the distribution of the capital stock of the former corporation to the stockholders of the Manufacturing *651 Co., the earned surplus and undivided profits of the Manufacturing Co. were charged with the sum of $366,125, the entries on the books being:
| $500 - | Surplus Acct. | |
| 364,500 - | Capital Stock Reyburn Corp. | |
| Bills Rec'ble | $365,625.00 | |
| 365,625 - | Surplus Acct. | |
| Capital Stock Reyburn Corp | 365,625.00 |
On or about December 16, 1931, the Reyburn Corporation entered into a written agreement whereby it acquired the real estate in Camden, New Jersey, heretofore mentioned, subject to the mortgages totaling $750,000. The consideration for this transfer was the delivery by the Reyburn Corporation to the late Walter C. Bailey of its 13 notes, aggregating $365,000, payable as follows: one note for $65,000, payable five years from December 16, 1931, and 12 notes, each in the amount of $25,000, payable annually on December 16, commencing six years from December 16, 1931, bearing interest at 5 per*1011 centum per annum.
After the consummation of the transaction involving the transfer of the notes by the Manufacturing Co. to the Reyburn Corporation for stock, the former company continued its corporate existence and is actively in business at the present time. After the transfer of the New Jersey property by the late Walter C. Bailey to the Reyburn Corporation for its notes, the latter company continued actively in the business of managing and operating that property, throughout 1932 and 1933 and until February of 1934, subsequent to the death of Walter C. Bailey. At that time foreclosure of the second mortgage on this property was imminent by reason of the inability of the Reyburn Corporation to meet interest payments on the mortgage on account of the decrease in the rental return from the property. A settlement was then effected with the holders of the second mortgage under which the Reyburn Corporation transferred the property to a corporation organized by the holders of the second mortgage bonds, in satisfaction of the principal and interest due under the second mortgage. Following this, the $365,000 of notes due from the late Walter C. Bailey, still held and uncollected*1012 by the Reyburn Corporation, were offset against the $365,000 of notes of the corporation held by the estate of Walter C. Bailey, and the Reyburn Corporation was thereupon dissolved.
In making their returns for the calendar year 1931, neither the late Walter C. Bailey nor his wife, petitioner Bertha M. Bailey, reported income from such receipt of shares of stock of the Reyburn Corporation or from the above transactions. In a later year, however, when question had been raised by respondent as to the taxability of these transactions and after the petitions herein had been filed, the *652 sum of $5,781.25 was paid on behalf of the late Walter C. Bailey to the collector of internal revenue for the first district of Pennsylvania as additional income tax and interest for the year 1931 as due upon a profit in the amount of the difference between the basis of the cost to Walter C. Bailey for the New Jersey property conveyed to the Reyburn Corporation and the face value of the notes of that corporation received in exchange.
OPINION.
LEECH: The two issues presented for decision are (1) whether Walter C. Bailey and his wife were taxable on their receipt of Reyburn Corporation*1013 stock in u931 and the proper measure of that tax if they are taxable, and (2) the correctness of the imposition of the tax on the sale of the New Jersey building by Walter C. Bailey to Reyburn Corporation, which has been paid.
The respondent treated Walter C. Bailey, deceased, and his wife, as being in receipt of ordinary taxable dividends in their receipt of Reyburn Corporation stock, and so taxed them under the provisions of the Revenue Act of 1928, section 115. The petitioners contend that the receipt of that stock was not so taxable because of the provisions of section 112(g) of the same revenue act.
Respondent argues that the transaction constituted a mere subterfuge by which Bailey and his wife, in effect, secured the distribution of a dividend from the Manufacturing Co., consisting of $365,000 of the surplus of that corporation which Bailey had borrowed from the corporation on his own notes.
Obviously, since Bertha M. Bailey was not a party to that borrowing and did not receive any part of it, she can not now be taxed on the theory that she did, unless we refuse to recognize Walter C. Bailey and his wife as two separate taxpayers. That premise would be unsound. *1014 ; ; sec. 51(b), Revenue Act of 1928.
Whether Bailey's borrowings from the Manufacturing Co., under the circumstances, might have been taxed as dividends to Bailey on their receipt, is not the question here. Because the business of the Manufacturing Co. under its charter did not include the loaning of money does not alter the fact that, on this record, it did loan money and that the notes evidencing those loans were assets of the company. Not only that, but the respondent did not consider these loans as dividends then and he does not do so now. The pending deficiencies involve a year after those in which the loans were made. Respondent supports these deficiencies against Bailey's estate and his widow by treating Bailey's notes as corporate assets distributed in the tax year as ordinary dividends, not only to him but to his wife, who was not a party to the loans and did not receive any part of them.
*653 Respondent agrees that the distribution of Reyburn Corporation stock to Walter C. Bailey and his wife, Bertha M. Bailey, falls literally within the provisions of section 112(i)(1)(B). *1015 He admits that if this distribution occurred "in pursuance of a plan of reorganization" within the meaning of section 112(g), no taxable gain resulted to the Baileys by reason of the receipt of the Reyburn Corporation stock. Respondent rests his position solely on the proposition that the Manufacturing Co.'s exchange of part of its assets in the form of the Bailey notes for all of the stock of the Reyburn Corporation was not "in pursuance of a plan of reorganization" as construed by the Supreme Court in .
The facts in the Gregory case were briefly as follows: In 1928, G owned all of the stock of U corporation. Among the assets of U corporation were 1,000 shares of the stock of M corporation. For the sole purpose of diminishing the amount of income tax on the sale of the M corporation stock, G caused the Averill Corporation to be organized. The Averill Corporation then acquired from the U corporation the stock of M corporation in return for the issuance to G of all of the stock of Averill Corporation. Six days after it was organized, Averill Corporation was dissolved and liquidated by distributing all of its assets, *1016 namely, the stock of M corporation, to G. No other business was ever transacted or intended to be transacted by Averill Corporation. G immediately sold the M shares. In reporting the gain from the sale for tax, G apportioned to the M shares part of the cost to G of the stock of U corporation. The issue was whether the entire gain from the sale of the M shares was taxable to G as an ordinary dividend from the U corporation. The Supreme Court decided that it was. In so holding, the Court held that while the transaction literally complied with section 112(g) of the Revenue Act of 1928, the exchange of the stock by U for Averill stock was not within the meaning of the statutory term, "in pursuance of a plan of reorganization." The Supreme Court, inter alia, said:
* * * When subdivision (B) speaks of a transfer of assets by one corporation to another, it means a transfer made "in pursuance of a plan of reorganization" (section 112(g)) of corporate business; and not a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either * * *.
Undoubtedly included within the "plan of reorganization" here were the organization*1017 of Reyburn Corporation, the exchange by the Manufacturing Co. of Bailey's notes for the stock of Reyburn Corporation, the distribution of that stock, pro rata, to the shareholders of the Manufacturing Co. without the surrender of their stock in that company, and the purchase by Reyburn Corporation of Bailey's New Jersey building, and its subsequent operation. See ; affd., ;
*654 If the plan was motivated solely by a purpose to escape tax, it would have had "no relation to the business of either [corporation]." ;. But the fact that tax avoidance or postponement was considered incidentally with a proper purpose or that such tax consequences followed is not material.
The Gregory case is readily distinguishable on its facts. The Manufacturing Co. was organized in 1895. Its reality and validity have not been and can not be questioned. *1018 Its dissolution was neither planned nor effected. It still exists. Nor was it planned that the Reyburn Corporation dissolve, nor did it do so, as a part of the "plan." See .
Respondent has disregarded that latter fact here and has imposed the tax upon receipt of the Reyburn Corporation stock in 1931 by Walter C. Bailey and his wife. He does this on either of two theories. The first is that Reyburn Corporation is not to be recognized as a legal entity. The second position, apparently, is that even if Reyburn Corporation is to be to recognized, "the plan", in pursuance of which the Manufacturing Co. exchanged part of its assets for all of Reyburn Corporation's stock, was prompted solely or primarily by a desire to avoid income taxes.
We disagree with both theories. There is no more reason to disregard the entity of Reyburn Corporation than that of the Manufacturing Co., the entity of which is admitted. ;; *1019 . In the Gregory case the Supreme Court specifically recognized the valid corporate entity of even the Averill Corporation, and there is much more substance and reality to Reyburn Corporation here. Undoubtedly it was organized for a business purpose. Whether the holding of the Bailey notes was such a purpose or not, the ownership and operation of the office building which it proposed to and did purchase from Walter C. Bailey, was. Thus, instead of dissolving and liquidating immediately after its receipt of assets from the Manufacturing Co. and the distribution of its stock to the stockholders of the latter company, Reyburn Corporation fulfilled its business purpose by owning and operating that building for a period of three years.
It was not until the end of that period, when foreclosure became imminent, that it then deeded the building to a corporation representing the owners of the second trust, rather than permit foreclosure. After that foreclosure and the death of Walter C. Bailey, Reyburn Corporation did dissolve and liquidate by offsetting its assets in the form of the Bailey notes against its own purchase money*1020 obligations in the same amount which the estate of Bailey held. It was then and not when the Reyburn Corporation stock was distributed to the *655 Baileys that they received Manufacturing Co. assets in the form of Bailey's notes. Until that liquidation occurred, petitioners were no closer to the exchanged assets than they were before and even then they were not received by them as a liquidating distribution.
Assuming, without deciding, the propriety of extending the rule announced by the Supreme Court in the Gregory case to a situation where, as here, dissolution and liquidation of the transferee corporation did not occur as part of "the plan", we think the rule can not be applied here. The elimination of the Bailey notes from the accounts receivable of the Manufacturing Co. was imperative to the maintenance and protection of its credit. The disposition or elimination of that item could have been accomplished in many ways. Undoubtedly the tax results of the plan as adopted and executed were considered. But this record convinces us that the motivating reasons for that plan were the necessary preservation of the credit of the Manufacturing Co. by the elimination of*1021 Bailey's notes from its accounts receivable and the segregation of those notes in the Reyburn Corporation with the New Jersey building which had been purchased by Bailey with the proceeds of those notes.
The owning and operation of the New Jersey building by the Reyburn Corporation may not have been related to the business of the Manufacturing Co. However, the transfer of the Bailey notes to Reyburn Corporation was thus related. The mainenance and protection of its own credit, thus accomplished, was directly and necessarily related to the business of the Manufacturing Co. That, in itself, is sufficient to characterize the plan which included the exchange by the Manufacturing Co. of the Bailey notes, a part of its assets, for all the Reyburn Corporation stock, as a "plan of reorganization" within section 112(i)(1)(B), supra, as construed by the Supreme Court in the Gregory case, supra.
It follows that the distribution of the Reyburn Corporation stock to Walter C. Bailey and his wife, Bertha M. Bailey, without the surrender of their Manufacturing Co. stock was within the provisions of section 112(g), supra, and was, therefore, not taxable. *1022 ;;; ; .
We decide the second issue for respondent. We can not agree with petitioners' contention that the payment for the account of the late Walter C. Bailey of $5,781.25 as additional tax and interest upon a claimed profit accruing from his sale of the New Jersey property to Reyburn Corporation constituted an overpayment of tax to a refund of which his estate is entitled. The property in question was sold to Reyburn Corporation for a consideration in excess of its cost to Walter C. Bailey. This consideration was paid in notes of the purchaser. *656 It is now argued by the executor that he property thus conveyed had no value. Consequently, they say it did not constitute an asset in the hands of the purchaser, that the only assets possessed by Reyburn Corporation standing back of its notes for $365,000 given to Bailey in the purchase were the notes in the same amount due from Bailey, which had*1023 been acquired by Reyburn Corporation in exchange for its stock and that these latter notes were uncollectible.
We are not impressed with this argument. It is not contended that Bailey was insolvent and the evidence shows that he was receiving a very large yearly income. Moreover, the notes of the face value of $365,000 received by him from Reyburn Corporation were usable to their full face value by his estate as an offset to notes in the same amount due from him and held by that corporation. Since the Reyburn Corporation notes received could have been used at any time by Bailey to save or offset the payment by him of $365,000, we think these notes had a value in his hands equal to their face value in view of the fact that his insolvency is not only not established but is contradicted. The record does not sustain the payment of this item as an overpayment of tax.
Decision will be entered under Rule 50.