*246 Decision will be entered under Rule 50.
1. Respondent's method of accounting for profit on reels sold by petitioner, approved.
2. Under a trust agreement executed in connection with a bond issue, petitioner covenanted that it would pay no dividends on any of its capital stock until the sinking fund requirements as to the bonds were paid or provided for. Held, after making provision for all sinking fund payments, the amounts distributable as dividends during the taxable years were in excess of the petitioner's adjusted net income for said years and no credit is allowable under section 26 (c) (1), Revenue Act of 1936; held, further, petitioner is entitled to no credit under section 26 (c) (2), since it was not required to make payments out of earnings and profits of the taxable year.
3. Held, petitioner is not entitled to credit under section 26 (c) (2), Revenue Act of 1936, for amounts paid in retirement of preferred stock, where it appeared that the stock was ordinary preferred stock, evidencing a capital investment rather than an indebtedness; held, further, petitioner is not entitled to deduct as interest amounts paid as dividends on such stock.
4. In 1936 dividends*247 on the petitioner's 7 percent cumulative preferred stock were in arrears by $ 31.50 per share. In December 1936 a plan of recapitalization was adopted, whereby the holders of the 7 percent preferred stock exchanged each share of said stock for 1.15 shares of new 6 percent preferred stock, and in addition received three-tenths of a share of 6 percent stock in payment of dividend arrears on the 7 percent stock, and one-tenth of a share of 6 percent stock to compensate for the difference in the call price between the 7 percent stock and the 6 percent stock. Held, (a) the transaction constituted a recapitalization of petitioner and was therefore a statutory reorganization; (b) the additional 6 percent stock was received pursuant to the plan of reorganization and not as a taxable stock dividend and under section 27 (h), Revenue Act of 1936, petitioner is not entitled to a dividends paid credit; (c) sections 115 (g) and 115 (f) (2), Revenue Act of 1936, are inapplicable; (d) respondent is not estopped from disallowing the claimed credit for dividends paid.
*619 The respondents determined deficiencies in income and excess profits taxes against the Okonite Co. for the years 1936 and 1937 as follows:
| Excess profits | ||
| Year | Income tax | tax |
| 1936 | $ 83,068.91 | |
| 1937 | 48,915.97 | $ 3,294.31 |
The following issues are involved:
(1) Whether the petitioner's method of reporting income from its transactions in reels accurately reflects income;
(2) Whether, under the provisions of section 26 (c) of the Revenue Act of 1936, the petitioner is entitled to any credits for 1936 and 1937 because of contracts restricting dividends;
(3) Whether amounts paid to stockholders in 1936 and 1937 on preferred stock are deductible as interest;
*620 (4) Whether preferred stock issued in 1936 constitutes a taxable stock dividend for which the petitioner*249 is entitled to a dividends paid credit; and, if not, whether the respondent is estopped from disallowing a credit claimed for dividends paid in 1936.
An issue in regard to additional deductions for depreciation for the years in controversy has been stipulated by the parties to be governed by the decision of the Supreme Court in the case of Virginian Hotel Corporation of Lynchburg v. Helvering, 319 U.S. 523">319 U.S. 523. Other issues raised by the pleadings were abandoned by the petitioner at the hearing.
FINDINGS OF FACT.
The petitioner is a corporation having its principal place of business at Passaic, New Jersey. Its income and excess profits tax returns for the years in controversy were filed with the collector of internal revenue for the fifth district of New Jersey.
The petitioner has operated continuously since 1878 at its Passaic plant, engaging in the manufacture and sale of insulated wires and cables. Its products range in size from ordinary lamp cords to cables which are about 4 1/2 inches in diameter.
Approximately 95 percent of the petitioner's products are shipped to customers on large wooden or steel reels. The balance, consisting of smaller *250 size wires, are coiled and delivered in cartons. The size of reels varies from a diameter of 24 inches for the small wooden reels to 120 inches for the larger steel reels.
The reels can be used several times for the shipment of wires and cables. Because of their value to the petitioner, it has been customary for many years to charge the customer for the reels and then to credit the customer when the reels are returned in good condition. The price charged is in excess of cost of the reels. The reels are not included in the price of the cables, but are charged separately, and no discount is allowed with respect to them. Reels returned in good condition within 12 months of the original date of shipment are credited at the price originally charged. Reels returned after 12 months are accepted unless obsolete but subject to a deduction for depreciation. Reels requiring repairs are accepted at the petitioner's option, in which case a reasonable charge for repairs is deducted from the credit allowance. In the price list of reels, the petitioner was referred to as "the seller."
The amount of the charge varies according to the size of the reel. A charge of $ 4 is made for a reel 24 *251 inches in diameter; a charge of $ 215 is made for a reel 96 inches in diameter. The petitioner manufactured some of the reels and purchased others.
The amounts received from the reels in excess of their cost are reflected on the petitioner's books in an account designated "Reel *621 Contingent Profit Reserve." At the time of shipment the petitioner credited to this account the excess of the amount charged to the customer for the reel over a "standard" cost of the reel, based on estimates originally made in 1930. When the reel is returned the account is debited with the amount in excess of cost attributable to such reel.
Each reel is numbered as it is shipped and a record is kept of the place of shipment, the name of the customer holding the reel, and the length of time it is held by him. The petitioner's records show that reels are ultimately returned to the extent of 90 percent. The petitioner's practice is to treat the amount of profit chargeable to the remaining 10 percent as earned profit, which is reflected on its books by an annual adjustment made for that purpose.
The petitioner's experience over a 10-year period shows that the reels are returned at an average rate *252 of about 40 percent within the year of shipment; about 32 percent within the next year; about 7 percent in the third year; 2 percent in the fourth year; 1 percent in the fifth year; and thereafter in each year by less than 1 percent. The petitioner's experience further shows that in years of increased activity the amounts credited to the reserve increase, but that in such years the reels are not returned as promptly as in years of lesser activity.
During 1936 and 1937 the total additions to the "Reel Contingent Profit Reserve" for profit on reels shipped out in those years were $ 155,145.61 and $ 179,907.83, respectively. Deductions from this account for previously credited profit on reels returned during such years were $ 131,823.39 and $ 167,646.78, respectively. The net increases to the "Reel Contingent Profit Reserve" account were $ 23,322.22 and $ 12,261.05, respectively. The petitioner returned as income in both years 10 percent of the total amounts added to that account during each year, i. e., $ 15,514.56 and $ 17,990.78.
In his notice of deficiency, the Commissioner added to income the sums of $ 23,322.22 and $ 12,261.05 for the respective years.
In 1927 petitioner entered*253 into a contract to purchase for $ 900,000 the insulated wire and cable business of the Hazard Manufacturing Co., a corporation located in Wilkes-Barre, Pennsylvania, which manufactured insulated wire and cable and steel rope. In order to raise sufficient money to carry out this contract, and for other purposes, the petitioner on December 1, 1927, issued $ 2,000,000 face amount of 15-year 5 1/2 percent sinking fund gold debentures and $ 1,000,000 par value of 7 percent cumulative preferred stock. All the bonds and all the stock were sold during 1927.
The bonds were issued under a trust agreement with the American Trust Co., dated December 1, 1927. Under this agreement the firm of Lee, Higginson & Co. was designated as both the paying agent and the *622 sinking fund agent. It was agreed that the amounts to be paid into the sinking fund would be sufficient to retire annually at least 3 1/2 percent of all the bonds and to retire at least 50 percent of the bonds before the date of maturity.
The agreement provided that the petitioner would pay to the sinking fund agent:
(1) Semiannually on April 15 and October 15 of each year, beginning April 15, 1928, and ending April 15, 1942, *254 the sum of $ 35,000;
(2) Annually on April 15 of each year, beginning April 15, 1928, and ending April 15, 1942, if the net income of the company for the preceding calendar year, after deducting (a) Federal income taxes, (b) accrued interest of petitioner's funded debt, and (c) accrued dividends on all outstanding shares of preferred stock, was such that 15 percent of the balance of the net income should be greater than the aggregate of the semiannual sinking fund payments during the preceding calendar year, the difference between such 15 percent of the balance of such net income and the aggregate of the semiannual sinking fund payments for such preceding calendar year.
All moneys received by the sinking fund agent were to be applied by it as soon as practicable to the redemption of the debentures at the lowest prices obtainable not exceeding their redemption price.
Under article 7 of the trust agreement, as well as by the specific provisions of each bond, the petitioner covenanted to reimburse those holders who were residents of Connecticut, Pennsylvania, or Massachusetts for income taxes imposed by those states on the interest received by bondholders resident therein.
Subsequent*255 to 1927 the Bank of the Manhattan Co. became substituted as trustee under the bond issue for the American Trust Co. The former company was also the sinking fund agent in 1936 and 1937.
In 1934 the petitioner was feeling the effects of the depression. It had operated at a loss for each of the three preceding years and, because of the requirements of the sinking fund, it was being drained of cash. As a result, its credit with the banks was becoming impaired.
To alleviate that condition, a plan was proposed for modification of the sinking fund provisions for the bonds. This plan, which was optional with the bondholders, provided as follows:
(a) The sinking fund provisions were altered so as to permit the petitioner to pay annually either $ 70,000 in cash or an aggregate principal amount of debentures of $ 70,000;
(b) If the petitioner's net income for the preceding calendar year, after deducting (1) $ 25,000, (2) Federal income taxes for that year, and (3) interest on the funded debt, was such that the balance of the net income equaled $ 70,000, then the payments were to be made in semiannual installments on April 15 and October 15, beginning with April 15, 1935;
*623 (c) If*256 the net income for the preceding year, after making the above mentioned deductions, was less than $ 70,000, the total balance was to be paid in the following year in cash or debentures at the option of the petitioner. Any difference between the amounts so paid and $ 70,000 was to be cumulative.
(d) If the net income for the preceding calendar year, after deducting (1) Federal income taxes, (2) interest on the funded debt, and (3) dividends accrued during such years on all outstanding shares of preferred stock, was such that 15 percent of the balance of the net income was greater than $ 70,000, the petitioner agreed to pay annually, either in cash or bonds, an amount equal to the difference between such 15 percent and $ 70,000.
The petitioner further agreed that it would "pay no dividends in any year hereafter on any of its capital stock and that it will make no payment in any year hereafter for account of the sinking fund provisions of its preferred stock, unless all the interest due or to become due on the Debentures to and including December 1 of such year shall have been paid or set apart and all payments and/or deposits to be made as herein provided, to and including October *257 15 of such year, for account of the sinking fund for the purchase and/or retirement of the Debentures, as provided for in this Plan, shall have been made or provided for."
Those bondholders who assented to the plan were entitled to receive interest on their bonds at the rate of 6 percent instead of 5 1/2 percent. As to those who did not assent to the plan, the terms of the original agreement remained in effect.
By September 25, 1934, 77.2 percent of the debentures had been deposited to evidence acceptance of the changes and the plan was declared operative at that date. Petitioner accordingly established the rate of 6 percent on such new bonds.
At December 31, 1935, petitioner had reacquired and canceled $ 664,000 of the $ 2,000,000 of bonds and had reacquired and held in its treasury $ 43,500, a total of $ 707,500, leaving bonds outstanding of $ 1,292,500. Of this total $ 43,500 was at the 5 1/2 percent rate and $ 1,249,000 was at the 6 percent rate.
During 1936 the petitioner, for the purpose of complying with the sinking fund provisions, purchased $ 99,500 face value of the 6 percent bonds and $ 5,000 face value of the 5 1/2 percent bonds, a total of $ 104,500. For the same purpose*258 the petitioner in 1937 purchased $ 93,000 face amount of 6 percent bonds and $ 3,500 face amount of 5 1/2 percent bonds a total of $ 96,500. During 1936 and 1937 the petitioner did not sell any of the bonds which it had purchased and did not at any time purchase any of its bonds for any purpose other than retirement through the sinking fund.
*624 On June 1, 1937, the Bank of the Manhattan Co. demanded a cash deposit of $ 35,000 to comply with the sinking fund requirements as to those bondholders who had not assented to the modification plan. The petitioner ignored this demand.
With respect to the 5 1/2 percent bonds, there remained a deficiency of $ 14,000 in the sinking fund at the end of 1936. At the end of 1937 there was no deficiency. With respect to the 6 percent bonds, there was no deficiency either in 1936 or 1937.
Prior to 1936 the petitioner's authorized capital stock was $ 6,000,000, divided into 60,000 shares of $ 100 par value, of which 10,000 shares were preferred and 50,000 shares common stock. The preferred stock issued December 1, 1927, was entitled to 7 percent cumulative dividends when and as declared by the board of directors before any dividends could*259 be paid on the common stock. It was callable at $ 115 per share, plus all unpaid dividends, whether or not earned or declared, to the date of redemption thereof.
A sinking fund was provided for the retirement of the preferred stock. The annual payments required to be made on account of the sinking fund were either $ 40,000 or an amount equal to 15 percent of the petitioner's net income after deducting preferred dividends and prior charges, whichever was the greater.
Dividends were declared regularly by the petitioner upon both the preferred and the common stock through October 27, 1931. On January 26, 1932, dividends on the common stock were passed and were passed continuously thereafter through December 10, 1936. On February 23, 1932, the regular 1 3/4 percent dividend was declared on the preferred stock. Dividends on the preferred stock were passed at a meeting held May 24, 1932, and continuously thereafter until August 17, 1936. On December 10, 1936, dividends of 1 1/2 percent were declared on the common stock.
In 1936 dividends on the preferred stock were in arrears by $ 31.50 per share. The company was also in arrears as to the sinking fund requirements on the preferred*260 stock and was short of cash.
On August 17, 1936, the dividend of $ 1.50 a share was declared on the preferred stock. At the same time an amendment to the petitioner's certificate of incorporation was proposed so that a plan might be adopted whereby the dividend arrears on the preferred stock would be eliminated.
On September 23, 1936, the certificate of incorporation was amended to authorize the issuance of a new class of 6 percent preferred stock, to consist of 11,000 shares of $ 100 par value per share, in addition to the preferred and common stock then authorized and outstanding. Dividends on the 6 percent stock which were cumulative could be paid only after payment of all cumulative dividends on the 7 percent *625 stock, but were payable before any dividends on the common stock. The entire amount of 6 percent stock outstanding was subject to redemption at any time at $ 105 per share, plus all unpaid dividends, whether or not earned or declared, to the date of redemption.
It was provided that the 6 percent stock should be entitled to the benefit of the sinking fund. The annual requirements for the sinking fund were declared to be an amount equal to 10 percent of the net*261 income of the corporation for the preceding calendar year after deducting therefrom:
(1) $ 50,000;
(2) Federal income taxes for the preceding year;
(3) Interest accrued during the preceding year on the funded debt of the corporation:
(4) All accumulated dividends on the outstanding 7 percent preferred stock;
(5) Accumulated dividends on the outstanding 6 percent preferred stock; and all prior charges.
On September 24, there was drafted a "Plan and Agreement for Recapitalization, Exchange of 7% preferred stock for 6% preferred stock and Payment of Dividends in Arrears on 7% Preferred stock." The plan, which was optional to holders of the 7 percent stock, offered "to each holder of said stock the right to exchange each share of his seven per cent preferred stock of the Company for one share and 15/100ths of a share of the Company's new six per cent preferred stock, plus an extra dividend on each share of his seven per cent stock of one-tenth of a share of the Company's new six per cent preferred stock and in connection with such exchange, to receive in payment of all arrears of dividends up to and including the quarterly dividend period ending September 1, 1936, on each share*262 of the seven per cent preferred stock exchanged as aforesaid, a stock dividend of three-tenths (3/10ths) of a share of new six per cent stock of the Company at par." All shares of 7 percent stock so exchanged were to be retired and canceled.
The plan was not to become effective unless substantially all of the holders of the 7 percent preferred stock agreed to the exchange.
As of December 7, 1936, holders of 6,824 shares out of a total of 6,952 had presented their stock for exchange and the plan was declared operative as of that date.
Appropriate entries were made in the petitioner's journal showing debits to surplus and credits to capital stock, as follows:
| $ 102,360. | To record the exchange of 6,824 shares of 7% Preferred stock for |
| 7,847.6 shares of 6% Preferred stock on basis of 1.15 of 6% for one | |
| share of 7% stock, in accordance with the plan for recapitalization. | |
| $ 204,720. | To record dividend of 3/10 of a share of 6% Preferred stock for |
| each share of 7% Preferred stock deposited in accordance with the | |
| plan of reorganization. This dividend is in payment of all arrears | |
| in dividends on the 7% Preferred stock to and including the | |
| quarterly dividend period ending 9/1/36 on stock deposited under the | |
| plan (6,824 shares x .3 -- $ 204,720.00). | |
| $ 68,240. | To record extra dividend of 1/10 of a share of 6% Preferred stock |
| for each share of 7% Preferred stock deposited in accordance with | |
| plan of recapitalization -- (6,824 shares x 1/10 -- $ 68,240). |
*263 *626 On December 10, 1936, a dividend of 30 percent was declared on the 7 percent stock which had not been exchanged pursuant to the plan of recapitalization, in full payment of the arrears of dividends on said stock.
By July 27, 1937, the holders of all but 121 shares of the 7 percent stock had deposited their stock pursuant to the plan. On that date the remaining 121 shares were called for redemption at the call price of 115 a share, plus dividends, and were retired and canceled at a cost to the petitioner of $ 13,915, or at a premium of $ 1,815.
Similarly, during 1936, 220 shares of the 7 percent stock had been purchased for redemption and cancellation at a cost of $ 25,798.75, or at a premium of $ 3,798.75.
On November 24, 1936, the petitioner declared a dividend of 1 3/4 percent on the 7 percent preferred stock payable December 1, 1936, to record holders as of November 24, 1936.
During 1937 cash dividends relative to the two classes of preferred stock were declared and paid, as follows:
| Date | 7% stock | 6% stock |
| Feb. 23 | 1 3/4 | 1 1/2 |
| May 25 | 1 3/4 | 1 1/2 |
| Aug. 24 | 1 3/4 | 1 1/2 |
| Oct. 26 | (Redeemed | 1 1/2 |
| July 27) |
Total cash dividends paid in 1937 were $ 158,388.75. *264 During the same year 6 percent preferred stock of a par value of $ 75,505 was purchased by the petitioner at a cost of $ 74,392.65 for the sole purpose of retirement through the sinking fund.
On March 5, 1937, petitioner's treasurer sent a letter to the preferred stockholders advising them that "the stock dividend of 30/100ths of a share of 6 per cent preferred stock * * * and the additional stock dividend of 10/100ths of a share of 6 per cent preferred stock * * * are taxable * * * as income to stockholders."
The petitioner also filed with the respondent Forms 1096 and 1099 in which it reported as taxable stock dividends the 30/100 and 10/100 of a share of 6 percent preferred stock issued December 7, 1936.
In March 1940 the respondent informed the petitioner that there was a question as to whether these shares of the 6 percent stock constituted taxable stock dividends. Because the period of limitation was about to expire, the petitioner's treasurer thereupon filed claims for refund on behalf of all the preferred stockholders. He sent another letter to the stockholders, advising them of his action and requesting them to *627 execute powers of attorney authorizing him to prosecute*265 the claims on their behalf. Some of the stockholders replied designating him their attorney for the purpose of securing the refunds.
The fair market value of the 6 percent preferred stock on December 7, 1936, was $ 89 per share.
The petitioner reported net income of $ 670,322.06 for 1936 and $ 808,969.46 for 1937 and adjusted net income for surtax computation of $ 570,936.81 and $ 688,790.76, respectively. Its surplus and undivided profits at the beginning of 1936 amounted to $ 559,044.62 and at the beginning of 1937 to $ 592,069.98.
OPINION.
The first question for determination is whether petitioner's method of accounting correctly reflects income with reference to its transactions in reels.
In addition to the contract price of goods sold, petitioner charged fixed amounts for the reels on which its wire and cable were shipped. These fixed amounts were in excess of the actual cost of the reels. This profit was placed in a reserve account styled "Reel Contingent Profit Reserve." As reels were returned the petitioner deducted from the account the amount of profit previously added for reels shipped. The net increases to the account for 1936 and 1937 were $ 23,322.22 and $ 12,261.05, *266 respectively. Petitioner's experience had shown that ultimately 90 percent of all reels were returned. Instead of returning as income the actual additions to this profit account, the petitioner adopted the practice of returning an amount equal to 10 percent of the gross additions to the account. Petitioner thus returned $ 15,514.56 and $ 17,990.78 for the taxable years.
The Commissioner added the amounts of $ 23,322.22 and $ 12,261.05 to income for the years 1936 and 1937, respectively, as representing additions to the account "Reserve for returnable reels."
The issue as now drawn presents the question whether the petitioner's income is reflected more clearly by including therein an arbitrary 10 percent of the total additions to the "Reel Contingent Profit Reserve" for each year, as proposed by petitioner, or by including in gross income the actual net additions to the reserve, as proposed by the respondent.
The petitioner contends that its 10 percent basis is justified by its experience, which shows that 90 percent of the amounts received for reels, including the profit on such reels, will have to be returned to the customers at a later date. The respondent argues that there *267 was a sale of the reels and that the actual net increase in the reserve is income for each year.
*628 It is settled that a reserve for returnable containers will not be allowed where it appears that there is an absolute sale of the container to the customers, subject to the customers' right to resell the container to the manufacturer. La Salle Cement Co. v. Commissioner, 59 Fed. (2d) 361; Beadleston & Woerz, Inc., 5 B. T. A. 165; Iten Biscuit Co., 25 B. T. A. 870; Plymouth Brewing & Malting Co., 16 B. T. A. 123.
There can be no doubt that the reels in the instant case were sold. There is nothing to show that the petitioner in any way retained title to them. The customer was charged the standard price for the reel and was free thereafter to keep it, to sell it elsewhere, or to return it to the petitioner. The petitioner agreed to repurchase at the original price those reels which were returned in good condition within 12 months from the date of shipment. Those that were returned in need of repair would be accepted only at the petitioner's option. *268 It is admitted that there was no way in which the customer could be forced to return the reels. A significant fact is that petitioner denominates itself in its price list of reels as the "seller." It is clear to us that there was in each case a sale of the reel to the customer and a resale to the petitioner.
It is also clear to us that petitioner's system of accounting for profit on the reels sold, by which it returns for taxation an arbitrary approximation of 10 percent of gross profit earned, does not accurately reflect income. By reference to the record it is readily established that the petitioner's income from the sale of reels during 1936 and 1937 was understated. On the other hand, petitioner, on whom rests the burden, has not demonstrated that respondent's method of accounting will not accurately reflect income if consistently applied over the years. Accordingly, we sustain the respondent's action.
The next question is whether petitioner is entitled to a dividends paid credit under the provisions of section 26 (c) (1) or section 26 (c) (2) of the Revenue Act of 1936. The contention is made in various alternatives. The applicable statutory provisions are set forth in *269 the margin. 1 Petitioner contends that the statutory credit is allowable *629 because prior to declaration of dividends it was compelled to contribute to the sinking fund either cash or debentures purchased for cash under a contract which, it contends, satisfies the requirements of either paragraph (1) or (2) of section 26 (c). The claim for credit as to the preferred stock is confined to section 26 (c) (2).
*270 Assuming that petitioner otherwise qualifies for credit under section 26 (c) (1), application of the specific statutory terms to petitioner's financial situation is, however, fatal to petitioner's contention. The statute limits the credit to "the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends," etc. In Regulations 94 the Commissioner has indicated how such credit should be computed.
At the beginning of 1936 the petitioner had surplus and undivided profits of $ 559,044.62. The respondent computed the petitioner's "adjusted" net income for surtax computation for the year 1936 to be $ 584,332.05, which, added to the surplus, makes total earnings of $ 1,143,376.67 available for dividends. The petitioner claimed a corresponding adjusted net income of $ 570,936.81. During 1936 the petitioner made payments on account of the sinking fund aggregating $ 104,500; at the end of that year it was in arrears as to these requirements by $ 14,000, making total sinking fund obligations for 1936 of $ 118,500. It is clear that, after deducting this amount from the petitioner's earnings for 1936, it still retained*271 a distributable balance of current and past earnings far in excess of its adjusted net income for that year.
A similar situation existed in 1937. In that year petitioner's "adjusted" net income, as computed by the respondent, was $ 702,065.42, and by the petitioner was $ 688,790.76. Its surplus and undivided profits at the beginning of that year were $ 592,069.98, making total earnings of $ 1,294,135.40 according to the respondent's figures. Its sinking fund requirements for that year were $ 70,000. Consequently, after making provision for these requirements, it still retained a balance of $ 1,224,135.40, which could have been distributed. This amount was greatly in excess of its net income for that year.
It follows that under the precise language of the statute the petitioner is not entitled to the credit under section 26 (c) (1), either for 1936 or 1937. Cf. Central West Coal Co., 44 B. T. A. 661; Thew Shovel Co., 45 B. T. A. 920.
The petitioner's contention that the credit should be allowed under section 26 (c) (2), supra, is equally untenable. That section grants a credit in an amount equal to that portion*272 of the earnings and profits of the taxable year which is required to be paid or set aside within the taxable year in discharge of a debt, to the extent so paid or set aside. In the present case there is no requirement that the payments for the *630 retirement of the bonds be made from the earnings or profits of the current year. They could be paid out of earnings accumulated from prior years or from any other source at the petitioner's disposal. The absence of such a requirement prohibits the allowance of the credit. A. E. Staley Manufacturing Co., 46 B. T. A. 199; C. A. Roberts Co., 44 B. T. A. 605; Lafayette Hotel Co., 43 B. T. A. 426; Hub Clothing House, Ltd., 39 B. T. A. 900.
The petitioner also contends that it is entitled to credit under section 26 (c) (2) for 7 percent and 6 percent preferred stock purchased in 1936 and 1937 for retirement through the sinking fund. The statutory requirement is that amounts so paid or set aside must be "in discharge of a debt." Therefore, the answer depends in part upon whether the preferred stock constituted *273 capital investment or an evidence of indebtedness. The stock had no fixed date of maturity. The dividends were payable only out of earnings when and if declared by the board of directors and were not payable out of funds at all events, a provision characteristic of interest. The stock had no priority over the claims of the general creditors of the corporation. There was no way in which payment could be forced in case of default. United States v. South Georgia Railway Co., 107 Fed. (2d) 3. All the characteristics of the preferred stock here in question show it to be a capital interest rather than an indebtedness. Consequently, credit under section 26 (c) (2) can not be allowed. May Hosiery Mills, Inc. v. Commissioner, 123 Fed. (2d) 858; Commissioner v. Meridian & Thirteenth Realty Co., 132 Fed. (2d) 182.
It may be added that there was no requirement that the stock should be purchased out of current earnings, an additional reason for the disapproval of petitioner's position.
By parity of reasoning, we may dispose of petitioner's contention that it was entitled to credit for*274 taxes refunded to bondholders.
What we have said above as to the character of the stock disposes also of the petitioner's contention that the dividends paid on its preferred stock in 1936 and 1937 should be deducted as interest.
The next issue is whether the petitioner is entitled to a dividends paid credit for certain of the 6 percent preferred stock issued in 1936. It is the petitioner's contention that four-tenths of a share of the 6 percent preferred stock issued in exchange for each share of the 7 percent preferred stock constitutes a stock dividend taxable to the stockholder and that it is, therefore, entitled to deduct the value thereof as a dividends paid credit under section 27 (e) of the Revenue Act of 1936. The respondent contends that the 7 percent preferred stock was exchanged for the 6 percent preferred stock in pursuance of a plan of reorganization under section 112 (b) (3); that the new stock received was not taxable in the hands of the shareholders; *631 and that, because of the restrictive provisions of section 27 (h), petitioner is not entitled to a dividends paid credit. The sections involved are noted in the margin. 2
*275 Briefly, the facts show that in 1936 petitioner was in arrears both as to the payment of dividends on the preferred stock and as to the sinking fund requirements on that stock. Consequently, a plan was devised whereby the sinking fund provisions would be made less stringent and the arrears on dividends eliminated. Under this plan, designated "Plan and Agreement for Recapitalization, Exchange of 7 percent Preferred for 6 percent Preferred Stock and Payment of Dividends in Arrears on 7 percent Stock," the holders of the 7 percent stock received in exchange for each share of such stock 1.15 shares of 6 percent stock, plus an extra dividend on each share of their 7 percent stock of one-tenth of a share of the 6 percent stock "and in connection with such exchange" received in payment of all arrears of dividends "a stock dividend of three-tenths (3/10ths) of a share of the new 6 percent stock of the company at par."
The holders of the 7 percent preferred stock were requested to waive the payment in cash of dividends on the 7 percent preferred stock and to accept in payment of said arrears of each share of 7 percent preferred stock a stock dividend of three-tenths of a share of the new*276 6 percent stock.
It is clear that this arrangement involved a recapitalization and was thus within the statutory definition of a reorganization as provided by section 112 (g) (1) (D). The petitioner does not deny the existence of a recapitalization, but contends that it extended only to the exchange of one share of 7 percent stock for 1.15 shares of 6 percent stock. It contends that the preferred stockholders received the 1.15 shares of the 6 percent in exchange for each share of 7 percent stock; that they received three-tenths of a share specifically by declaration of dividend to pay them the dividends that stood in arrears on the 7 percent *632 stock; and that they received one-tenth of a share as an extra dividend specifically so declared to compensate them for the difference in the call price on the 7 percent stock and on the 6 percent stock.
This contention is similar to that made in Skenandoa Rayon Corporation, 42 B. T. A. 1287; affd., 112 Fed. (2d) 268; and Knapp Monarch Co., 1 T. C. 59; affd., 139 Fed. (2d) 863. In the Skenandoa case the dividends *277 on the petitioner's preferred stock were in arrears in the amount of $ 45.50 a share. In order to discharge this liability a plan of recapitalization was adopted whereby the preferred stockholders received 1.4 shares of new 5 percent preferred stock and $ 5.50 in cash for each share of the old preferred stock and a release of all claims on unpaid dividends. Petitioner contended that the reorganization extended only to the exchange of one share of the old stock for one share of the new stock and that the payment of four-tenths of a share of the new stock and the $ 5.50 was, in effect, the payment of a dividend of $ 45.50. It was held, however, that the consideration for the stock and cash was not divisible, but was both the surrender of the old stock and the right to accumulated dividends, and that credit should be allowed the corporation only to the extent of the cash paid.
In Knapp Monarch Co., supra, the petitioner had outstanding 9,630 shares of $ 3.25 cumulative preferred stock on which dividends were in arrears of $ 7.65 a share. A plan of reorganization was adopted which provided, among other things, that the $ 3.25 stock be exchanged share *278 for share for new $ 2.50 cumulative preferred stock and that a dividend of one-half share of common stock be declared and paid to the recipient of each share of the new preferred stock in consideration of their exchange of the old stock for the new. The petitioner contended that the one-half share of common stock was outside of the reorganization and not a part of the exchange but was the payment of a taxable dividend separate and apart from the exchange. In answer we said:
To say that the holders of the old preferred stock surrendered their old preferred shares in exchange only for the shares of new preferred would require the rewriting of the plan of reorganization * * * Since the common stock was in fact issued pursuant to the plan of reorganization and was a part of the consideration for the exchange of the old preferred stock, and, being the shares of the corporation reorganized, the exchange falls squarely within the provision of section 112 (b) (3), supra.
The petitioner attempts to distinguish the above cases by showing that the financial condition of the corporation involved in each case was such that in no event could it have declared a taxable stock dividend. This*279 point was not discussed in the Skenandoa case. In the Knapp Monarch case it was pointed out that no contention had been made that the company did not have enough earnings and profits to declare a dividend or that there was a nontaxable stock dividend.
The petitioner's contention must be rejected. The language used in *633 the plan of recapitalization clearly shows that the consideration for the exchange of each share of 7 percent stock was the receipt of 1.55 shares of 6 percent stock and that it can not be separated into two or more independent steps. The plan specifically provided that the holders of the 7 percent stock should receive in exchange for each share thereof 1.15 shares of the 6 percent stock, "plus an extra dividend * * * of 1/10th of a share of * * * 6 per cent preferred stock, and in connection with such exchange to receive in payment of all arrears of dividends * * * a stock dividend" of three-tenths of a share of new 6 percent stock. (Italics added.) It, therefore, falls within the provisions of section 112 (b) (3) of the Revenue Act of 1936. Consequently, the stock received is not taxable to the stockholders as a stock dividend and the *280 petitioner is not entitled to the dividends paid credit, as provided in section 27 (h).
The cases cited by the petitioner in support of its argument are distinguishable, since none of them involved a statutory plan of reorganization.
Petitioner next contends that the redemption and cancellation of the 7 percent stock constituted in part a distribution of stock taxable as a dividend under section 115 (g) of the Revenue Act of 1936. That section provides in part that the amount distributed in redemption or cancellation of stock to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend. However, this is limited by the provisions of section 115 (h) of the Revenue Act of 1936, providing that a distribution by a corporation of its stock or securities shall not be a distribution of the earnings or profits if no gain to the distributee of the stock or securities is recognized by law. We have already held that because of the provisions of section 112 (b) (3) no gain or loss is recognizable to the recipients of the 6 percent stock. Hence, section 115 (g) is inapplicable. South Atlantic Steamship Line, 42 B. T. A. 705;*281 Louis A. Wellhouse, Jr., 3 T.C. 363">3 T. C. 363.
Petitioner also relies on section 115 (f) (2) of the Revenue Act of 1936. That section sets forth conditions under which a stock dividend may be taxable to the shareholders. We have already held that no stock dividend was declared in the case at bar, but that there was only an exchange of preferred stock for preferred stock, pursuant to the plan of reorganization. Hence, this section is inapplicable.
Petitioner contends that in any event respondent is now estopped from claiming that the corporation is not entitled to a dividends paid credit since he has already ruled that the dividends are taxable to the stockholders and has collected taxes from them. In answer, we may say that there is no evidence that the respondent ever made any ruling relative to the taxability of the dividends prior to the determination *634 herein, nor do we have any information as to the taxes paid by the stockholders. However, even if the petitioner were correct in its assertions, the elements of estoppel are not present, since there is no showing that the petitioner suffered any detriment as the result of any prior action on the*282 part of the respondent, an essential element of estoppel. Crossett Lumber Co. v. United States, 87 Fed. (2d) 930. It is fully established that the Commissioner of Internal Revenue may reexamine and redetermine a taxpayer's liability within the period of limitation. Knapp Monarch Co. v. Commissioner, 139 Fed. (2d) 863, and cases there cited. We reject petitioner's contention.
In its brief petitioner attempts to raise an issue as to whether the petitioner is entitled to deduct the amounts paid in 1936 and 1937 as reimbursements for local taxes to bondholders residing in Connecticut, Pennsylvania, and Massachusetts. No such issue is pleaded and we decline to entertain it.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 26. CREDITS OF CORPORATIONS.
In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax --
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(c) Contracts Restricting Payment of Dividends. --
(1) Prohibition on Payment of Dividends. -- An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * *
(2) Disposition of Profits of Taxable Year. -- An amount equal to the portion of the earnings and profits of the taxable year which is required (by a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the disposition of earnings and profits of a taxable year) to be paid within the taxable year in discharge of a debt, or to be irrevocably set aside within the taxable year for the discharge of a debt; to the extent that such amount has been so paid or set aside. * * *↩
2. SEC. 27. CORPORATION CREDIT FOR DIVIDENDS PAID.
* * * *
(e) Taxable Stock Dividends. -- In case of a stock dividend or stock right which is a taxable dividend in the hands of shareholders under section 115 (f), the dividends paid credit with respect thereto shall be the fair market value of the stock or the stock right at the time of the payment.
* * * *
(h) Nontaxable Distributions. -- If any part of a distribution (including stock dividends and stock rights) is not a taxable dividend in the hands of such of the shareholders as are subject to taxation under this title for the period in which the distribution is made, no dividends paid credit shall be allowed with respect to such part.
SEC. 112. RECOGNITION OF GAIN OR LOSS.
* * * *
(b) Exchanges Solely in Kind. --
* * * *
(3) Stock for stock on reorganization. -- 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.↩