*172 In Docket Nos. 26117, 30080 and 30081 decisions will be entered for the petitioners.
In Docket Nos. 26116, 26118 to 26124, inclusive, decisions will be entered under Rule 50.
Pursuant to readjustment of corporate structure, preferred stock owned by petitioners was exchanged for newly issued debentures. Held, in the circumstances of this case, the exchange was tax free under section 112 (b) (3) and (g), I. R. C.Bazley v. Commissioner, 331 U.S. 737">331 U.S. 737, distinguished.
*502 The question for decision is whether a distribution of debentures made by the Jersey Publishing Company in August 1942, in cancelation and redemption of its preferred stock resulted in the receipt of taxable income by the distributees. The Commissioner's determination that the debentures represented income, taxable in full, was the basis for his assertion of the following deficiencies in income tax:
| Docket | |||
| number | Petitioner | Year | Deficiency |
| 26116 | Daisy Seide | 1943 | $ 129,852.77 |
| 26117 | Harold Seide | 1943 | 24,398.67 |
| 26118 | Joan Fagan Rohn | 1943 | 27,830.11 |
| 26119 | Lois Fagan | 1943 | 27,830.11 |
| 26120 | Elisabeth Fagan | 1943 | 7,646.15 |
| 26121 | Marilyn Fagan | 1943 | 7,638.69 |
| 26122 | Constance A. Fagan | 1943 | 7,633.55 |
| 26123 | Robert A. Fagan | 1943 | 7,652.00 |
| 26124 | Peter S. Fagan | 1943 | 7,633.55 |
| 30080 | Joan Fagan Trust | 1942 | 27,032.00 |
| 30081 | Lois Fagan Trust | 1942 | 27,032.00 |
*173 *503 Although the distribution occurred in 1942, both 1942 and 1943 are involved in Nos. 26116-26124, inclusive, by reason of the application of the Current Tax Payment Act of 1943.
Joan Fagan Rohn and Lois Fagan, the petitioners in docket numbers 26118 and 26119, respectively, are the income beneficiaries of the trusts which are the petitioners in docket numbers 30080 and 30081, respectively. The respondent as a matter of precaution sent deficiency notices to the beneficiaries and to the trusts. He now concedes that if any taxable income was realized as a result of the distribution of debentures to the trusts it is taxable to them and not to the beneficiaries.
FINDINGS OF FACT.
The stipulated facts are so found.
The income tax returns of the petitioners for the taxable years were filed with the collector of internal revenue for the fifth district of New Jersey.
Jersey Publishing Company (hereinafter sometimes referred to as the "Company") was incorporated under the laws of the State of New Jersey in January 1892. It was originally known as the Hoboken Printing and Publishing Company, and its business has at all times consisted of the ownership and publication of a daily *174 newspaper in Hoboken, New Jersey, formerly known as the Hudson Observer and known at the time of the hearing as the Jersey Observer (hereinafter sometimes referred to as the "Observer").
The Company originally had an authorized capital stock of $ 5,000, consisting of 50 shares of the par value of $ 100 per share, which in February 1894 was increased to $ 15,000, consisting of 150 shares of the par value of $ 100 per share, and which in December 1918 was further increased to $ 500,000, consisting of 5,000 shares of the par value of $ 100 per share. Of this authorized capital stock, all of which was of the same class, the Company issued 132 shares, for cash or property, before June 1898; and 4,868 shares, as a stock dividend, on December 7, 1922. All of the issued shares were outstanding until December 21, 1925, when the Company recapitalized thereby changing its authorized capital stock to consist of 3,200 shares of preferred stock and 1,800 shares of common stock, each of the par value of $ 100 per share; and it then issued all of the preferred stock and 1,600 shares of the new common stock in exchange for the 5,000 shares of the old common stock, all of which were then surrendered*175 and canceled. The Company, all of its shareholders, and the United States Treasury Department have at all times regarded and treated the exchange of shares of capital stock as a tax free transaction for Federal income tax purposes. In July 1929, the Company created, in addition to its then authorized common and preferred stock, 2,500 shares of no par common stock without any voting rights, which it then issued as a dividend *504 on its outstanding common stock. Although the board of directors was empowered to distribute dividends to both classes of common stock "at such times and in such manner as they may deem advisable," subsequent resolutions of the board of directors and the shareholders made it clear that both classes of stock were to have the same right to dividends.
The preferred stock of the Company entitled the holders to receive cumulative dividends at the rate of 8 per cent per year, and $ 100 per share and unpaid accrued dividends on liquidation of the Company, payable before any payment on the common stock. This preferred stock had no voting power, and it was subject to redemption at $ 110 per share and accumulated dividends.
In August 1942, the Company, pursuant*176 to an agreement between the holders of the preferred stock, resolutions of its board of directors (approved by its stockholders entitled to vote), resolutions of the stockholders, and amendment of its certificate of incorporation accordingly, acquired from the holders of its preferred stock all of the 3,200 shares of its preferred stock for retirement, and, in exchange therefor, issued to them its debentures in the ratio of $ 1,000 face value of debentures for 10 shares of preferred stock of the par value of $ 100 per share. The Company then canceled and retired its preferred stock so acquired.
Each of the debentures reads as follows:
Jersey Publishing Company, a corporation organized under the laws of the State of New Jersey, (hereinafter called the Company), for value received, hereby promises to pay to the registered holder of this debenture, upon surrender thereof at the office of the Company in the City of Hoboken, State of New Jersey, One Thousand Dollars ($ 1,000.00) on June 1st, 1962, unless previously redeemed, and to pay interest thereon quarter-annually from June 1st, 1942, at the rate of eight per cent. (8%) per annum, on March 1st, June 1st, September 1st and December*177 1st in each year. * * *
* * * *
The time for the payment of the entire issue, of which this debenture is a part, may be extended for an additional period of twenty (20) years from the due date thereof, with interest at the rate of eight per cent. (8%) per annum, payable quarter-annually, during the extended period, by the written consent of the registered holders of at least two thirds (2/3rds) in amount of the debentures outstanding, provided that such written consents be filed at the principal office of the Company on or prior to June 1st, 1962.
The payment of the entire issue, of which this debenture is a part, may be subordinated to the payment of any other obligations or debts of the Company by the written consent of the registered holders of at least two-thirds (2/3rds) in amount of the debentures outstanding, specifying the particular debt or debts, obligation or obligations, to which the issue is to be thus subordinated.
This debenture shall become immediately due and payable upon the adoption by the stockholders of the Company of an effective resolution for the voluntary dissolution or winding up of the Company, or upon the entry of a judgment or decree of any court of competent*178 jurisdiction, dissolving the Company, or if the Company is adjudicated a bankrupt or insolvent by a court of competent *505 jurisdiction, or if a decree is made by a court of competent jurisdiction for the reorganization of the Company under the provisions of the National Bankruptcy Act.
This debenture may be redeemed by the Company at any time after June 1st, 1952, at its face value plus interest earned and unpaid thereon, upon thirty (30) days' notice to the registered holder thereof.
* * * *
The owners of the preferred stock of the Company, the preferred shares transferred by them to the Company, and the face value of the debentures received by them from the Company in August 1942 were as follows:
| Preferred | Face value | |
| Shareholder | shares | of debentures |
| transferred | received | |
| Daisy Seide | 1,300 | $ 130,000 |
| Harold Seide | 300 | 30,000 |
| Joan Fagan Trust | 400 | 40,000 |
| Lois Fagan Trust | 400 | 40,000 |
| Elisabeth Fagan | 160 | 16,000 |
| Marilyn Fagan | 160 | 16,000 |
| Robert Anthony Fagan | 160 | 16,000 |
| Peter Shelley Fagan | 160 | 16,000 |
| Constance Anne Fagan | 160 | 16,000 |
| Total | 3,200 | $ 320,000 |
The 1,300 shares of preferred stock of the Company transferred to it in August 1942 by *179 Daisy Seide were then owned by her and were acquired by her, by way of gift, from Frederick A. Seide, who had acquired 800 shares thereof from the Company in the recapitalization on December 21, 1925, and 500 shares thereof, by way of gift, from Hester Seide, who acquired the 500 shares, by way of gift, from Gustavus A. Seide, who acquired them from the Company in the recapitalization on December 21, 1925.
The 300 shares of the preferred stock of the Company transferred to it in August 1942 by Harold Seide were then owned by him and were acquired by him, by way of gift, from Gustavus A. Seide, who acquired them from the Company in the recapitalization on December 21, 1925.
The 400 shares of the preferred stock of the Company transferred to it in August 1942 by the Joan Fagan Trust and the Lois Fagan Trust, respectively, were then owned by each trust and were acquired by it, by way of gift, as follows: 250 shares from Mary A. Fagan and 150 shares from Arthur L. Fagan, each of whom had acquired the respective shares from the Company in the recapitalization on December 21, 1925.
The 160 shares of the preferred stock of the Company transferred to it in August 1942 by Elisabeth Fagan, Marilyn*180 Fagan, Robert A. Fagan, Peter S. Fagan, and Constance A. Fagan, respectively, were then owned by each of them and were acquired by each of them, by way of gift, from Elizabeth M. Fagan, who acquired the respective shares, by way of gift as follows: 500 shares from Arthur L. Fagan *506 and 300 shares from Mary A. Fagan, each of whom acquired the respective shares from the Company in the recapitalization on December 21, 1925.
The holders of the common stock of the Company, the old common shares transferred by them to the Company, and the shares of new common and preferred stock received by them from the Company in the recapitalization on December 21, 1925, were as follows:
| Old common | New common | Preferred | |
| Shareholder | shares | shares | shares |
| transferred | received | received | |
| Gustavus A. Seide | 1,250 | 400 | 800 |
| Frederick A. Seide | 1,250 | 400 | 800 |
| Mary A. Fagan | 1,250 | 400 | 800 |
| Arthur L. Fagan | 1,250 | 400 | 800 |
| Total | 5,000 | 1.600 | 3,200 |
Of the 1,250 shares of the old common stock of the Company transferred thereto on December 21, 1925, by Gustavus A. Seide, Frederick A. Seide, Mary A. Fagan, and Arthur L. Fagan, respectively, 1,217 shares were acquired by each*181 of them, by way of the Company's aforesaid stock dividend, in December 1922; and the remaining shares were acquired as follows: Gustavus A. Seide acquired 33 shares before March 1, 1913; Frederick A. Seide acquired 33 shares, by way of gift, from Gustavus A. Seide, who acquired them before March 1, 1913; Mary A. Fagan acquired 33 shares, by way of inheritance on May 9, 1921, from Lawrence Fagan, who acquired them before March 1, 1913; and Arthur L. Fagan acquired 33 shares, by way of gift, from Mary A. Fagan, who acquired them, by way of gift, from Lawrence Fagan, who acquired them before March 1, 1913.
The owners of the common stock and debentures, respectively, of the Company when the debentures were issued in August 1942, and thereafter in 1942 and 1943, are shown in the following table:
| Shares of common stock | ||||
| Face amount | ||||
| Owner | of debentures | |||
| Voting | Non-voting | Total | ||
| Daisy Seide | 850 | 850 | $ 130,000 | |
| Harold Seide | 200 | 300 | 500 | 30,000 |
| Joan Fagan Trust | 200 | 200 | 40,000 | |
| Lois Fagan Trust | 200 | 200 | 40,000 | |
| Frederick A. Seide | 600 | 100 | 700 | |
| Arthur L. Fagan | 800 | 100 | 900 | |
| Elizabeth M. Fagan | 500 | 500 | ||
| Arthur L. Fagan, Jr., Trust | 250 | 250 | ||
| Elisabeth Fagan | 16,000 | |||
| Marilyn Fagan | 16,000 | |||
| Robert A. Fagan | 16,000 | |||
| Peter S. Fagan | 16,000 | |||
| Constance A. Fagan | 16,000 | |||
| Total | 1,600 | 2,500 | 4,100 | $ 320,000 |
*182 There has been no change in the ownership of the debentures since they were issued in August 1942.
*507 The table below shows (1) the daily average circulation of the Observer; (2) the Company's income from advertising; (3) its net sales (consisting of its income from advertising, circulation, subscriptions, job work and waste paper, less discounts and allowances); (4) its gross income; (5) its net income; and (6) the total dividends, cash and stock, respectively, paid by it for the calendar years 1911 to 1942, inclusive.
| Sales | |||
| Daily | |||
| Year | average | ||
| circulation | |||
| Advertising | Total | ||
| 1911 | 35,184 | $ 238,017 | $ 311,184 |
| 1912 | 36,294 | 239,935 | 333,025 |
| 1913 | 36,865 | 234,675 | 335,598 |
| 1914 | 37,991 | 218,753 | 320,705 |
| 1915 | 38,602 | 233,602 | 345,150 |
| 1916 | 39,103 | 275,050 | 406,805 |
| 1917 | 41,206 | 291,490 | 438,525 |
| 1918 | 39,858 | 322,833 | 514,784 |
| 1919 | 43,399 | 477,899 | 703,643 |
| 1920 | 43,727 | 655,032 | 941,555 |
| 1921 | 42,011 | 705,954 | 1,107,893 |
| 1922 | 40,388 | 758,756 | 1,093,940 |
| 1923 | 41,106 | 783,946 | 1,142,869 |
| 1924 | 41,773 | 820,344 | 1,197,932 |
| 1925 | 42,339 | 842,268 | 1,220,537 |
| 1926 | 40,887 | 882,026 | 1,205,818 |
| 1927 | 40,861 | 907,541 | 1,273,863 |
| 1928 | 43,293 | 956,732 | 1,308,509 |
| 1929 | 45,414 | 1,005,575 | 1,366,298 |
| 1930 | 43,638 | 870,656 | 1,240,247 |
| 1931 | 43,447 | 804,110 | 1,172,992 |
| 1932 | 40,409 | 663,429 | 990,581 |
| 1933 | 37,251 | 621,485 | 927,545 |
| 1934 | 36,547 | 617,450 | 906,927 |
| 1935 | 37,674 | 638,436 | 937,823 |
| 1936 | 38,214 | 612,418 | 921,630 |
| 1937 | 38,739 | 603,340 | 920,949 |
| 1938 | 37,176 | 553,369 | 868,176 |
| 1939 | 37,138 | 578,247 | 895,887 |
| 1940 | 37,555 | 569,660 | 910,382 |
| 1941 | 37,666 | 586,487 | 938,434 |
| 1942 | 39,628 | 525,835 | 931,338 |
| Total income | Dividends paid | |||
| Year | ||||
| Gross | Net | Cash | Stock | |
| 1911 | $ 311,394 | $ 95,397 | ||
| 1912 | 333,687 | 72,669 | $ 40,700 | |
| 1913 | 335,966 | 85,939 | 40,500 | |
| 1914 | 320,965 | 66,921 | 35,610 | |
| 1915 | 345,635 | 70,058 | 43,000 | |
| 1916 | 407,429 | 96,579 | 64,000 | |
| 1917 | 439,544 | 89,254 | 92,000 | |
| 1918 | 515,870 | 14,993 | 13,000 | |
| 1919 | 706,100 | 86,542 | 13,250 | |
| 1920 | 943,045 | 124,756 | 60,000 | |
| 1921 | 1,115,965 | 231,895 | 60,000 | |
| 1922 | 1,101,891 | 204,856 | 66,000 | $ 486,800 |
| 1923 | 1,147,683 | 200,872 | 48,000 | |
| 1924 | 1,220,622 | 207,976 | 52,000 | |
| 1925 | 1,240,910 | 122,260 | 60,000 | |
| 1926 | 1,221,662 | 97,871 | 1 269,600*184 | |
| 1927 | 1,295,660 | 135,983 | 94,869 | |
| 1928 | 1,341,517 | 2 146,421 | 65,600 | |
| 1929 | 1,389,145 | 134,312 | 79,100 | 250,000 |
| 1930 | 1,262,132 | 106,068 | 131,850 | |
| 1931 | 1,192,610 | 26,364 | 105,600 | |
| 1932 | 1,009,005 | 69,233 | 69,350 | |
| 1933 | 945,556 | 56,014 | 61,850 | |
| 1934 | 921,815 | 25,290 | 85,600 | |
| 1935 | 950,308 | 36,831 | 65,600 | |
| 1936 | 933,301 | 21,589 | 68,100 | |
| 1937 | 936,122 | 5,455 | 25,600 | |
| 1938 | 883,920 | (18,350) | 19,200 | |
| 1939 | 911,925 | (17,410) | ||
| 1940 | 924,579 | 3 (17,113) | ||
| 1941 | 951,265 | (852) | 25,600 | |
| 1942 | 944,616 | 17,318 | 12,800 |
The balance sheets of the Company for the years 1940, 1941, and 1942 are reflected in the following table:
| 1940 | 1941 | 1942 | |
| Assets | |||
| Cash | $ 161,779.62 | $ 173,059.49 | $ 193,179.71 |
| Notes and accounts receivable | 95,276.98 | 104,598.60 | 87,921.12 |
| Cash reserve | 84,692.14 | 82,855.90 | 82,855.90 |
| United States obligations | 62,306.25 | 62,306.25 | 62,306.25 |
| Chamber of Commerce bonds | 2,000.00 | 2,000.00 | 2,000.00 |
| Municipal bonds | 3,600.00 | ||
| Stocks (investment) | 73,585.00 | 41,500.00 | 41,500.00 |
| Other property | 307,350,87 | 299,021.07 | 295,284.14 |
| Total assets | $ 790,590.86 | $ 765,341.31 | $ 765,047.12 |
| Liabilities | |||
| Accounts payable | $ 26,121.46 | $ 27,324.85 | $ 22,511.83 |
| Net tangible assets: | |||
| Debentures | 320,000.00 | ||
| Capital stock | 480,000.00 | 480,000.00 | 160,000.00 |
| Earned surplus | 284,469.40 | 258,016.46 | 262,535.29 |
| Liabilities and net tangible | |||
| assets | $ 790,590.86 | $ 765,341.31 | $ 765,047.12 |
*508 The "other property" shown in the balance sheets of the Company, per its books, as of December 31, 1941 and 1942, consisted of *185 the following:
| December 31, 1941 | |||
| Item | Depreciation | ||
| Cost | reserve | Balance | |
| Real estate: | |||
| 111 Newark Street: | |||
| Land | $ 26,082.68 | $ 26,082.68 | |
| Building | 75,665.46 | $ 38,989.43 | 36,676.03 |
| 80 Washington Street: | |||
| Land | 6,300.00 | 6,300.00 | |
| Building | 74,490.18 | 30,556.20 | 43,933.98 |
| 56-60 Park Avenue: | |||
| Land | 8,440.00 | 8,440.00 | |
| Building | 4,363.00 | 2,670.42 | 1,692.58 |
| 2866 Hudson Boulevard: | |||
| Land | 39,110.00 | 39,110.00 | |
| Building | 72,144.15 | 21,218.19 | 50,925.96 |
| Total real estate | 306,595.47 | 93,434.24 | 213,161.23 |
| Three presses | 145,796.37 | 115,457.09 | 30,339.28 |
| Autoplate | 23,194.27 | 22,807.04 | 387.23 |
| Other machinery | 244,685.25 | 221,552.41 | 23,132.84 |
| Furniture and fixtures | 24,113.57 | 17,552.17 | 6,561.40 |
| Horse and wagon | 367.00 | 201.84 | 165.16 |
| Automobiles, inventory and | |||
| prepaid items | 29,560.56 | 4,286.63 | 25,273.93 |
| Total | $ 774,312.49 | $ 475,291.42 | $ 299,021.07 |
| December 31, 1942 | |||
| Item | Depreciation | ||
| Cost | reserve | Balance | |
| Real estate: | |||
| 111 Newark Street: | |||
| Land | $ 26,082.68 | $ 26,082.68 | |
| Building | 75,665.46 | $ 39,883.97 | 35,781.49 |
| 80 Washington Street: | |||
| Land | 6,300.00 | 6,300.00 | |
| Building | 74,490.18 | 32,613.40 | 41,876.78 |
| 56-60 Park Avenue: | |||
| Land | 8,440.00 | 8,440.00 | |
| Building | 4,363.00 | 2,776.21 | 1,586.79 |
| 2866 Hudson Boulevard: | |||
| Land | 39,110.00 | 39,110.00 | |
| Building | 72,144.15 | 22,460.29 | 49,683.86 |
| Total real estate | 306,595.47 | 97,733.87 | 208,861.60 |
| Three presses | 145,796.37 | 120,513.67 | 25,282.70 |
| Autoplate | 23,194.27 | 23,194.27 | |
| Other machinery | 251,316.30 | 224,788.95 | 26,527.35 |
| Furniture and fixtures | 24,122.52 | 18,356.93 | 5,765.59 |
| Horse and wagon | 367.00 | 201.84 | 165.16 |
| Automobiles, inventory and | |||
| prepaid items | 35,265.62 | 6,583.88 | 28,681.74 |
| Total | $ 786,657.55 | $ 491,373.41 | $ 295,284.14 |
*186 In August 1942, the property (land and building) at 111 Newark Street had an aggregate fair market value of $ 29,500; the property (land and building) at 80 Washington Street had an aggregate fair market value of $ 14,900; the property (land and building) at 56-60 Park Avenue had an aggregate fair market value of $ 6,300; and the property (land and building) at 2866 Hudson Boulevard had an aggregate fair market value of $ 57,400.
Of the three newspaper presses of the Company two were purchased in 1922 and one in 1924. The press purchased in 1924 was manufactured in 1909 and had been used before 1924. The two presses purchased in 1922, through mistakes in their manufacture, did not do good printing from the beginning. They were badly worn in 1942 and, as a result, the printing of the Observer was unsatisfactory, inferior to the printing of its competitors, and brought complaints from advertisers. The Company sought to replace its presses in 1937, when it could have purchased new presses of the kind suitable for the Observer at a cost of from about $ 86,900 to $ 95,000 for each press. Its two 1922 presses then had a trade-in value of from $ 8,200 to $ 8,500. By 1945 the cost of*187 new newspaper presses of the kind which the Company deemed it required advanced to about $ 140,000 for each press. In 1942 the Company had 18 linotype machines, and they were then very old, badly worn, and obsolete. In January 1942 it replaced one of these machines with a new one for $ 5,109. The condition of the Company's plant as a whole in 1942, from its physical *509 and operational point of view, was deteriorated and obsolete. The building and plant were obsolete; the equipment was in bad condition; and the machines were old and badly worn.
The Observer, an evening paper, had two competitors in and about its territory: the Jersey Journal in Jersey City, New Jersey (hereinafter referred to as the "Journal"), an evening newspaper of general circulation; and the Hudson Dispatch in Union City, New Jersey (hereinafter referred to as the "Dispatch"), a morning newspaper of general circulation. Beginning some time in or before the middle 1930's the Observer began to lose ground to both its competitors. Among the conditions hindering the Observer were its obsolete plant and inadequate machinery.
The issuance of the debentures in exchange for the preferred stock of the Company*188 in 1942 was decided upon by its officers as a means of saving money for the Company (1) by the deduction of the interest on the debentures for tax purposes and the resulting reduction of income taxes; (2) by the reduction of the outstanding capital stock of the Company and the resulting reduction of the New Jersey franchise tax; and (3) the elimination of accumulated, but unpaid, dividends on the preferred stock of the Company, which in August 1942 amounted to $ 57,600.
The debentures of the Company would not in 1942 or 1943 have been accepted by a bank as collateral for a loan, and they were not readily marketable.
The redemption and cancelation of the preferred stock of the Company and the issuance of its debentures in August 1942 were not essentially equivalent to the distribution of a taxable dividend.
OPINION.
The New Jersey Publishing Company had three classes of stock outstanding in August 1942: 1,600 shares of voting common, 2,500 shares of non-voting common, and 3,200 shares of non-voting 8 per cent cumulative preferred having a par value of $ 100. The shares of stock were held as follows:
| Voting | Non-voting | ||
| Owner | common | common | Preferred |
| Daisy Seide | 850 | 1,300 | |
| Harold Seide | 200 | 300 | 300 |
| Joan Fagan Trust | 200 | 400 | |
| Lois Fagan Trust | 200 | 400 | |
| Frederick A. Seide | 600 | 100 | |
| Arthur L. Fagan | 800 | 100 | |
| Elizabeth M. Fagan | 500 | ||
| Arthur L. Fagan, Jr., Trust | 250 | ||
| Elisabeth Fagan | 160 | ||
| Marilyn Fagan | 160 | ||
| Robert A. Fagan | 160 | ||
| Peter S. Fagan | 160 | ||
| Constance A. Fagan | 160 | ||
| Total | 1,600 | 2,500 | 3,200 |
*189 *510 Pursuant to a plan of readjustment of its corporate structure, the Company issued a total of $ 320,000 face amount 8 per cent 20-year debentures in August 1942, and exchanged the debentures for all its preferred stock, each holder receiving a $ 1,000 debenture for 10 shares of preferred stock. The Company canceled the stock thus received and adjusted the capital on its books accordingly. In determining the deficiencies originally, the Commissioner apparently took the position that the distribution of the debentures in redemption and cancelation of the preferred stock was essentially equivalent to the distribution of a taxable dividend, within the meaning of section 115 (g) of the Internal Revenue Code. The Commissioner now makes that contention only as to the four petitioners who held common (either voting or non-voting), and argues that the other five realized capital gain upon receipt of the debentures and that they have not proved their basis in the preferred stock which they surrendered. We hold that the exchange of debentures for preferred stock was not essentially the equivalent of a taxable dividend and that the exchange was tax free pursuant to section 112 (b)*190 (3).
Section 112 (b) (3) provides for the nonrecognition of gain or loss "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 * * *." And section 112 (g) (1) (E) defines "reorganization" to include "a recapitalization." There was here in fact a readjustment of the Company's capital structure, and there was an exchange of preferred stock solely for debentures. The transaction literally falls within the foregoing statutory provisions (cf. Wolf Envelope Co., 17 T. C. 471), and unless there are considerations which render these provisions inapplicable they are dispositive of the present controversy.
The situation here is wholly unlike that presented in Bazley v. Commissioner, 331 U.S. 737">331 U.S. 737, where the form of reorganization was employed in an effort to achieve the distribution of a disguised dividend, and where it was held that the reorganization provisions were not intended to govern in such circumstances. The net effect of the transaction in the Bazley case was a pro rata distribution of debentures*191 among stockholders in such manner as to render them the substantial equivalent of a cash dividend. No such circumstances are present here. The exchange of debentures for the preferred did not even remotely resemble a pro rata distribution of debentures among the holders of the two classes of common stock, considered either separately or together.
Five holders of the preferred stock owned no common stock whatever. The holders of 87 1/2 per cent of the voting common owned no preferred and thus received no debentures. Similarly, several holders *511 of a substantial block of non-voting common owned no preferred and likewise received no debentures. And finally, those holders of common who also owned preferred received debentures in percentages entirely unrelated to their holdings of common. To be sure, it is not a sine qua non of a taxable dividend that the distribution be made pro rata among the stockholders. But the fact that an alleged distribution is highly disproportionate raises a serious question whether it is in truth a disguised dividend.
Moreover, the debentures here involved were not readily marketable by reason of the following considerations: They were unsecured*192 and had a remote maturity date, without likelihood of acceleration except in the event of dissolution or insolvency; there was the risk that they might be subordinated to the payment of other obligations; the Company had obsolete plant and equipment, and its business was in an unhealthy state, having sustained net losses in four of the five preceding years and having fared poorly in relation to its competitors. The petitioners have asked us to find that the debentures had no fair market value at all. This we have not done, but the factors outlined above do show that the debentures could not readily have been sold, notwithstanding the Company's relatively strong balance sheet, and this fact is an additional element to be considered in determining whether the transaction was in fact a distribution of earnings rather than the reorganization which it purported to be. Taking all the facts into account we conclude that there was not here a distribution essentially equivalent to a taxable dividend. The Bazley case is not controlling; indeed, it points in the other direction.
Nor are the reorganization provisions inapplicable by reason of the absence of a "business purpose." One of*193 the reasons for the elimination of the preferred stock was to wipe out the accumulated "deficit" in unpaid dividends, and we have no reason to conclude on this record that such objective was not attained. This was a valid business or corporate purpose (cf. Okonite Co. v. Commissioner (C. A. 3), 155 F. 2d 248, 250, certiorari denied 329 U.S. 764">329 U.S. 764; Thermoid Co. v. Commissioner (C. A. 3), 155 F.2d 589">155 F. 2d 589, 590; Morainville v. Commissioner (C. A. 6), 135 F.2d 201">135 F. 2d 201; Skenandoa Rayon Corp. v. Commissioner (C. A. 2), 122 F.2d 268">122 F. 2d 268, certiorari denied 314 U.S. 696">314 U.S. 696; H. Grady Manning Trust, 15 T. C. 930, 942), and the reorganization provisions, which otherwise literally cover this controversy, cannot therefore be rendered inapplicable.
In Docket Nos. 26117, 30080 and 30081 decisions will be entered for the petitioners.
In Docket Nos. 26116, 26118 to 26124, inclusive, decisions will be entered under Rule 50.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: Harold Seide; Joan Fagan Rohn; Lois Fagan; Elizabeth Fagan, a Minor, and Elizabeth M. Fagan, Substituted Guardian; Marilyn Fagan, a Minor, and Elizabeth M. Fagan, Substituted Guardian; Constance Anne Fagan, a Minor, and Elizabeth M. Fagan, Substituted Guardian; Robert Anthony Fagan, a Minor, and Elizabeth M. Fagan, Substituted Guardian; Peter Shelley Fagan, a Minor, and Elizabeth M. Fagan, Substituted Guardian; Elizabeth M. Fagan. Sole Surviving Trustee for Joan Fagan Trust; and Elizabeth M. Fagan, Sole Surviving Trustee for Lois Fagan Trust.↩
1. In 1926 the Company reduced its surplus on account of dividends declared in the amount of $ 269,600, of which $ 69,600 was paid in 1926. The remaining $ 200,000 was set up as a liability in 1926 on the Company's books and was paid off in 1927, 1928, and 1929 in the amounts of $ 66,700, $ 66,660 and $ 66,640, respectively.↩
2. Including income taxes refunded credited to surplus.↩
3. Including accounts receivable reduction charged to surplus.↩