*1109 1. Extra compensation based upon a percentage of annual net profits paid to two employees, from whom petitioner had acquired numerous patents and applications for letters patent, held, in the circumstances, to be deductible in the year in which paid.
2. By an original return filed for 1924, the petitioner changed from the accrual to the installment basis of reporting income. The Commissioner adjusted petitioner's returns for several prior years to the installment basis and refunded the difference in the amount of tax paid upon the accrual basis and the amount computed upon the installment basis. In these circumstances, held, the Commissioner properly included in the incomes of 1924, 1925, and 1926, the amount of the collections in those years upon installment sales made prior to 1924.
3. In 1926, in a taxable transaction, the petitioner disposed of its installment sales contracts. Held, he petitioner realized at that time the deferred profit upon such contracts and the amount of the then realized profit was properly included in its taxable income for 1926.
*530 These proceedings, duly consolidated, are for the redetermination of the following income tax deficiencies:
| Docket No. | Year | Deficiency |
| 32986 | 1924 | $24,573.08 |
| Do | 1925 | 6,145.70 |
| 44700 | 1926 | 45,855.03 |
The pleadings, as amended, raise the following issues: (1) Whether the Commissioner erred by capitalizing alleged bonus payments to designers; (2) whether the Commissioner erred in including in taxable income of the respective years the collections in those years on installment sales made prior to 1924; and (3) whether the Commissioner "in computing the tax liability for the calendar year 1926 has erroneously increased income in the amount of $322,980.29, which amount represents the reserve for unrealized profit on installment sales." The facts were stipulated.
FINDINGS OF FACT.
The petitioner is an Illinois corporation, with its principal office at Rockford. During the taxable years 1924, 1925, and 1926 the petitioner, under the name of Rockford Milling Machine Co., was engaged inthe manufacture of milling and adding machines. In June 1926, *1111 the name of the taxpayer was changed to Sundstrand Corporation, and in December 1926, its name was changed to John A. Nelson Co.
In December 1923, the petitioner entered into a contract with Gustaf David Sundstrand and Oscar J. Sundstrand, which was *531 designated as "GENERAL AGREEMENT WITH INVENTORS." In so far as material here, the contract is as follows:
WHEREAS, the Company's entire product consists of machines invented and designed by the parties of the first part; and,
WHEREAS, the below mentioned United States patents have been granted to the Company on inventions made by the parties of the first part: [Here follows list of nine patents.]
and,
WHEREAS, the below-mentioned foreign patents have been granted to the Company on inventions made by the parties of the first part: [Here follows list of eight patents.]
and
WHEREAS, the parties of the first part have filed applications for letters patent of the United States, which applications may be identified in the U.S. Patent Office as follows: [Here follows list of 18 applications for letters patent.]
and
WHEREAS the parties of the first part have filed applications for foreign letters patent as follows: *1112 [Here follows list of eight applications for letters patent.]
and
WHEREAS the parties of the first part have assigned the entire right, title and interest in said applications, including foreign patent rights, to said Company with the eral understanding that an agreement should be arrived at for the payment of special compensation to the parties of the first part; and
WHEREAS the parties of the first part have invented other improvements in milling machines, link grinders, adding, listing and calculating machines and cash registers; and
WHEREAS the parties of the first part may make further inventions and improvements relating to the lines of machinery manufactured by the Company; and
WHEREAS, said Company desires to acquire all such inventions and improvements relating to the lines of machinery manufactured by the Company which may be made by the parties of the first part during the term of this agreement * * *:
Now, THEREFORE, in consideration of the promises and of their mutual promises herein set forth and of the payment of One Dollar to the parties of the first part, by said Company, the receipt and sufficiency of which considerations are hereby acknowledged, the*1113 parties hereto have agreed together as follows, to wit:
1. The parties of the first part hereby agree to disclose to said Company all inventions relating to milling machines, link grinders, double end lathes, adding, listing and calculating machines and cash registers * * * which they or either of them have heretofore made or may hereafter make during the term of this agreement; to execute at any time upon request, without further or additional consideration, but at the expense of said Company, applications for original, divisional, renewal, reissue or extended letters patent of the United States or of any and all foreign countries on such inventions; to assign the entire right, title and interest in and to all such inventions to said Company; and to render all necessary assistance in making application for and in obtaining such letters patent, and in enforcing any rights or choses in action accruing as a result of such applications or patents, by giving testimony in any proceedings or transactions involving such applications or patents, and by executing preliminary statements and other affidavits.
*532 2. The company agrees to pay to the parties of the first part, their*1114 legal representatives or assigns, five per centum (5%) of the net profits of the Company from any and all sources, * * *
* * *
8. The term of this agreement shall be from and including January 1, 1923, to the end of the term of the last to expire of the United States letters patent granted to said Rockford Milling Machine Company under this agreement, it being understood that if the business of said Company shall be divided as provided for in Paragraph 7 hereof, the obligations of said first parties and of the new corporation set forth in said paragraph shall continue to the end of the term of the last to expire of the letters patent assigned or granted to such corporation in accordance with Paragraph 1 hereof.
9. This agreement shall bind and inure to the benefit of the successors, legal representatives and assigns of the parties hereto.
All of the patents and applications for letters patent referred to in the above agreement had been assigned to the petitioner by the Sundstrands, who were in the employ of the petitioner at all times material to our determination. The Sundstrands worked on the inventions during business hours and conducted their experiments with petitioner's*1115 tools and materials. The petitioner had paid and borne all costs of developing, securing, prosecuting, maintaining, and defending the several patents and applications for letters patent.
On December 31, 1923, Gustaf David Sundstrand owned 351 shares and Oscar J. Sundstrand owned 260 shares of a total of $8,250 shares of petitioner's outstanding common stock of the par value of $100 per share.
For the taxable years before us, the petitioner, under the contract, paid the Sundstrands, and in its returns for these years deducted, as compensation for services rendered, the following amounts:
| 1924 | $15,827.68 |
| 1925 | 19,371.18 |
| 1926 | 23,030.83 |
The respondent disallowed the claimed deductions. He respondent capitalized these payments, to which he added a similar payment for 1923, and has applied the capital expenditure equally to the several United States patents referred to in the contract. Upon the basis of the remaining term of each of these patents at the end of the respective years, the respondent has allowed deductions for the amortization of these expenditures as follows:
| 1924 | $1,289.63 |
| 1925 | 1,739.76 |
| 1926 | 6,344.26 |
The petitioner*1116 kept its books and prepared its income tax returns on the accrual basis, except as hereinafter indicated.
In its original return for the year 1924, filed prior to February 26, 1926, the petitioner changed its method of reporting income to *533 the installment basis, and the respondent approved the change. The petitioner reported its income for 1925 and 1926 upon the installment basis.
The respondent recomputed the petitioner's income tax liability for the years 1918 to 1923, inclusive, and refunded to the petitioner the excess of the tax returned and paid for those years on the accrual basis, above the amount of the tax computed upon the installment basis for those years.
In its returns for 1924 and 1925 the petitioner excluded amounts received in each of those years on account of installment sales made prior to 1924. In determining the deficiencies, the respondent has included such payments in petitioner's income for these years. The amounts excluded by the petitioner and included by the respondent are as follows:
| 1924 | $294,452.65 |
| 1925 | 29,009.86 |
In its return for 1926 the petitioner included in its income $6,864.68 as profits received in 1926*1117 on account of installment sales made prior to 1924.
On November 18, 1926, the petitioner and Elliott-Fisher Co., a Delaware corporation, entered into an agreement which, in so far as material here, is as follows:
The [Elliott-Fisher] Company shall cause a new corporation to be organized having a presently issued capital stock consisting of
(a) 12,500 shares of $7.00 preferred stock of the par value of $100. each; [provision was made for the issuance of additional shares and for the retirement of this preferred stock at stated intervals] * * * The $7.00 preferred stock shall have no voting power unless dividends thereon at the rate herein provided shall be in default in the amount of at least $7.00 per share. * * *
(b) 30,000 shares of common stock without nominal or par value; * * * Each holder of common stock shall be entitled to one vote for each share of such stock held by him.
It is agreed notwithstanding the foregoing that the new corporation may issue such additional shares of $7.00 preferred stock as may be necessary or desirable in connection with the settlement hereunder of the Profit and Loss of the Sundstrand Corporation [petitioner] between September 30, 1926 and*1118 the closing date of the purchase herein contemplated * * *. The new corporation may also issue from time to time such additional shares of common stock as may be deemed necessary or desirable for any purpose.
The new corporation shall be incorporated under the Laws of such state and shall have such powers and charter provisions and such by-laws as counsel for the company may deem necessary or advisable, not inconsistent, however, with the provisions contained herein with respect to the common and preferred stock of the new corporation.
Sundstrand Corporation [petitioner] will convey and transfer all of the Sundstrand Corporation's property including, without limitation by reason of the enumeration thereof, all of the property and assets of the Sundstrand *534 Adding Machine Company of Illinois, the Sundstrand Canadian Adding Machine Company, Limited of Toronto, Canada, the Sundstrand Adding Machine Sales Company, Inc., and of all other subsidiary companies, if any, and the land and buildins to be acquired as hereinabove provided from Sundstrand Machine Tool Company to the new corporation or its nominee or nominees, free of any lien, incumbrance, indebtedness or charge*1119 thereon or with respect thereto, which could or might affect the title thereto; except, however it shall not convey and transfer the sum of $100,000.00 in cash which is to be retained by the Sundstrand Corporation. * * *
Simultaneously with said transfer, the [Elliott-Fisher] Company will cause the new corporation to issue to or in accordance with the direction of Sundstrand Corporation [petitioner], 12,500 shares of the $7.00 preferred stock of the new corporation and to pay to said Sundstrand Corporation, $2,000,000.00 in cash; provided that the Company will also cause the new corporation, as soon as the facts with respect thereto can be ascertained and determined, to issue to or in accordance with the direction of the Sundstrand Corporation, such additional shares of the $7.00 preferred stock of the new corporation as shall equal at $100.00 per share, the amount of net profit, if any, of the Sundstrand Corporation, arising from its business from and after September 30, 1926, to the date of said transfer and provided also that if a loss shall result from the operation of the Sundstrand Corporation's business in the period from and after September 30, 1926, to the date of said*1120 transfer, said 12,500 shares of the $7.00 preferred stock of the new corporation shall be reduced on the basis of one share for each $100.00 of such loss. The net profit of the Sundstrand Corporation for the period from September 30th, 1926 to the date of said transfer as herein provided, shall be calculated in accordance with good accounting practice.
Simultaneously with, or at the Company's option before, said transfer of the Sundstrand Corporation's property to the new corporation, the Company will cause the new corporation to issue to the Company, 30,000 shares of its common stock upon payment therefor by the Company of the sum of $2,000,000.00 in cash.
Sundstrand Corporation has submitted to the Company, a financial statement of its assets and liabilities as of September 30, 1926. Said financial statement indicates tangible assets in excess of $2,420,000; Liabilities of approximately $331,000 and Tangible Net Worth in excess of $2,090,000.00, It is represented that the estimated net profit for the year 1926, after all taxes, bonuses and other charges, will be approximately $400,000.00. * * *
Sundstrand Corporation represents that at the time of such transfer of the*1121 Sundstrand Corporation's property to the new corporation, the net worth of Sundstrand Corporation will be such that the financial status of the new corporation will then be as good or better than that shown by the tentative balance sheet hereto annexed and marked Exhibit A, less $100,000 in cash, plus any operating profits made by the Sundstrand Corporation, between September 30, 1926 and the date of such transfer.
* * *
The new corporation may at its option use the name Sundstrand Corporation or Sundstrand as or as a part of its corporate name or that of any of its subsidiaries, and the Sundstrand Corporation will when and as requested by the new corporation or the Company make any necessary change in its corporate name or that of any of its subsidiaries or otherwise so that the new corporation and its subsidiaries may be in a position to register to do business in any state in the United States or elsewhere.
*535 On November 18, 1926, at a special meeting of the petitioner's stockholders, called -
* * * for the purpose of considering and acting upon a proposition made to this Corporation to sell and dispose of all of its property and assets and for the transaction*1122 of any and all business pertaining to the consideration of and action upon said proposal or necessary in connection therewith,
the following resolutions were adopted:
RESOLVED that the Stockholders of the Company in meeting duly assembled hereby approve said Agreement, and authorize and direct the sale and transfer of all the property and assets of this Company upon the terms and conditions therein provided; and further
RESOLVED that the Board of Directors and Officers of this company be and they hereby are authorized and directed to take such steps and to execute such instrument or instruments including said Agreement, with such modifications thereof or supplements thereto, as in their opinion may be necessary or desirable in order to effect such sale and transfer; and further
RESOLVED, that upon the consummation of said reorganization and sale, the proceeds consisting of preferred capital stock and cash received from such sale be distributed immediately to the stockholders in the order of their preferential rights, the preferred stock being first fully redeemed and the balance distributed to the common stockholders; and further
RESOLVED, that this corporation, after the*1123 consummation of said re-organization and sale under the said agreement with Elliott-Fisher Company and the distribution of the proceeds in accordance with the reorganization plan to its stockholders in the manner provided above, shall cease operation, and the directors and officers thereof shall proceed to liquidate the corporation and cause the same to be dissolved.
The further unanimous action was taken, as recorded in the following minutes of that meeting:
RESOLVED that the name of this Corporation be and is hereby changed from SUNDSTRAND CORPORATION to John A. Nelson Co.
Pursuant to the terms of the agreement with Elliott-Fisher Co., the petitioner's properties were transferred to a new corporation, organized under the laws of the State of Delaware, and the petitioner received therefor 14,060 shares of the preferred stock of the new corporation and $2,000,000 in cash. The petitioner immediately used part of the cash so received to retire its own preferred stock and distributed the 14,060 shares of the new company's preferred stock and the balance of the cash to its common stockholders.
As of December 31, 1926, the books of the petitioner showed a reserve for "Unrealized*1124 Profit" on installment sales in the amount of $322,980.29. The respondent added the $322,980.29 to petitioner's income in arriving at the deficiency here in question, on the ground that when it exchanged its assets for stock and cash the petitioner collected 100 percent for the total outstanding installment accounts receivable. Included in the $322,980.29 is an amount of $1,640.49 representing uncollected profits on sales made prior to 1924. The *536 $1,640.49 is not included in the $6,864.68 representing collections on prior installment sales, reported in 1926.
OPINION.
SMITH: The petitioner contests the respondent's disallowance of the deductions claimed by reason of the payment of 5 percent of its net profits to the Sundstrands in each of the taxable years before us. The respondent has treated these amounts as capital expenditures, applying them to the several United States patents, and has allowed deductions for their amortization over the remaining term of the patents. The petitioner argues that the patents had been acquired prior to the payments now in question and that:
* * * Instead * * * of giving the Sundstrands a bonus in some fixed and perhaps arbitrary*1125 amount, petitioner and the Sundstrands agreed to have the extra compensation measured by the direct index of the effect of the services of the Sundstrands - petitioner's profits. * * *
The Board has held that the cost of patents, legal expenses incident to procuring and protecting the patents, and experimental expenses in connection with their development are capital expenditures. See Beaumont Co.,3 B.T.A. 822">3 B.T.A. 822; American Seating Co.,4 B.T.A. 649">4 B.T.A. 649; affd. on this point, 50 Fed.(2d) 681; Buffalo Forge Co.,5 B.T.A. 947">5 B.T.A. 947; Grand Rapids Show Case Co.,12 B.T.A. 1024">12 B.T.A. 1024. See also Dempster Mill Mfg. Co. v. Burnet, 46 Fed.(2d) 604. However, we also held in American Seating Co., supra, that an item of $15,000 representing royalty payments was not to be treated as a capital expenditure.
The agreement with the Sundstrands recited that the petitioner had been granted nine domestic and eight foreign patents on inventions made by the Sundstrands, who had also assigned to the petitioner their entire rights to eighteen domestic and eight foreign applications for letters patent. *1126 Apparently, if the amounts in question are to be treated as capital expenditures, the capitalization must be with respect to both foreign and domestic patents and applications therefor.
While the Sundstrands owned shares of stock in the petitioner, no point is made that the payments bore any relation to their stockholdings. Their services were doubtless of value to the petitioner and, in recognition of the Sundstrands' contributions to the success of the enterprise, the petitioner agreed to pay them a percentage of its annual net profits. Whether we consider the payments based upon a percentage of profits as compensation for services rendered (see Tyler & Hippach, Inc.,6 B.T.A. 636">6 B.T.A. 636, 641), or as in the nature of a rental or royalty for the use of the product of their inventive genius (see Webb Press Co., Ltd.,3 B.T.A. 247">3 B.T.A. 247; Office Decision 440, Cumulative *537 Bulletin No. 2, p. 215), such payments were in satisfaction of an obligation relating directly to the business of the particular year for which they were paid. We can not see that these payments add anything to the petitioner's capital investment, it having already acquired the*1127 patents and applications therefor. There are further practical difficulties in treating these payments, relating to the business of a particular year and measured by the success of that year's operations, as capital expenditures. These difficulties are the changing base upon which to rest an amortization allowance, the variable terms of the several patents, and the term of the agreement as opposed to the term of the patents, requiring the payments to the Sundstrands even in the last year of the term of a patent or patents, but not requiring payments in a year when there were no profits, even though the cost of the patents would nevertheless be subject to amortization. In these circumstances, we hold that the respondent erred in capitalizing the expenditures involved and that the deductions claimed should be allowed. Cf. Jamison Coal & Coke Co.,24 B.T.A. 554">24 B.T.A. 554; Hutchison Coal Co.,24 B.T.A. 973">24 B.T.A. 973; affd., 64 Fed.(2d) 275; L. Schepp Co.,25 B.T.A. 419">25 B.T.A. 419, 430; In re General Film Corp.,274 Fed. 903.
The second issue is whether the amounts collected in the respective taxable years upon installment sales made*1128 prior to 1924 are to be included in the income of the year of collection. The petitioner relies upon the provisions of section 705(a)(2) of the Revenue Act of 1928, which is as follows:
(a) If any taxpayer by an original return made prior to February 26, 1926, changed the method of reporting his net income for the taxable year 1924 or any prior taxable year to the installment basis, then, if his income for such year is properly to be computed on the installment basis -
* * *
(2) No deficiency shall be determined or found in respect of any such taxes unless the taxpayer has underpaid his taxes for such year, computed by excluding, in computing income, amounts received during such year on account of sales or other dispositions of property made in any year prior to the year in respect of which the change was made.
The facts are not in dispute, and, viewing the matter purely from the standpoint of the original installment sales returns for 1924 and subsequent years, the petitioner is within the letter of the statute. But, "A thing may be within the letter of a statute and not within its meaning, and within its meaning, though not within its letter. *1129 The intention of the lawmaker is the law." Smythe v. Fiske,23 Wall. 374">23 Wall. 374, 380. We have held that where a taxpayer, by an original return filed within the time prescribed by statute, changes from the accrual to the installment basis of reporting its income, "no deficiency shall be determined on account of amounts received during the taxable *538 year from sales made in years prior to that of the change to the installment basis." Tull & Gibbs, Inc.,21 B.T.A. 1073">21 B.T.A. 1073, 1074. See also S. Davidson & Bros., Inc.,21 B.T.A. 638">21 B.T.A. 638; Grand Rapids Show Case Co., supra.
In Jacob Bros. Co. v. Commissioner, 50 Fed.(2d) 394, 396, the Circuit Court of Appeals for the Second Circuit determined that uncollected profits upon installment sales which had been reported upon the accrual basis should be included in invested capital of the years following a change to the installment basis of reporting income. The court said, inter alia:
* * * Section 705 permits the taxpayer to exclude from the later year's income cash collected on installment contracts reported on the accrual basis in years prior to the*1130 change of method. In other words, the accrual method was allowed to stand unaffected in respect to income for years prior to 1918. Hence the surplus and undistributed profits account obtained by the accrual method is likewise unaffected by the change. * * * [Italics supplied.]
Under section 212(d) of the Revenue Act of 1926, the Commissioner was given authority to prescribe regulations for reporting income upon the installment basis. Article 42, Regulations 69, provides such regulations for reporting income from the sale of personal property on the installment plan, and further that:
The provisions of this article shall be retroactively applied in computing income from the sale of personal property under the Revenue Acts of 1916, 1917, 1918, 1921, and 1924, or any such Acts as amended. (See section 1208). Any dealer in personal property on the installment plan whose books of account contain adequate information and were kept so that income can be accurately computed on the installment basis in accordance with the provisions of this article may file amended returns accordingly, and the excess of the amount of any tax previously paid over the tax as computed on the installment*1131 basis as herein provided shall, subject to the statutory period of limitations properly applicable thereto, be credited or refunded as provided in section 284 and articles 1301-1306.
The facts show that the respondent recomputed the petitioner's tax liability for the years 1918 to 1923, inclusive, and refunded to the petitioner the excess of the tax paid for those years on the accrual basis above the amount of the tax computed upon the installment basis. The petitioner, having received the benefit of such readjustments to its income, insists that it should receive a further benefit by excluding the amount of the collections in 1924, 1925, and 1926 upon installment sales prior to 1924 from its income for those years. We do not believe such dual benefits were intended by Congress. The accrual method used by this taxpayer was not allowed to stand and is affected by the adjustments made by the respondent, and the refunds accepted by the petitioner in accordance with article 42 of Regulations 69. "Men must turn square corners when they deal with the *539 Government." *1132 Rock Island, A. & L.R. Co. v. United States,254 U.S. 141">254 U.S. 141. This petitioner, having received the benefit of the change to the installment basis of reporting income, not only for the years following the change but also for the years prior to that change, should not be heard to complain because the respondent has included in its income for 1924, 1925, and 1926, amounts representing collections upon installment sales of prior years, which otherwise would go untaxed. Otherwise, this petitioner's true income would not be properly returned for taxation. In these circumstances, the respondent is sustained.
The remaining issue is whether the respondent has erroneously included in income for 1926 an amount of $322,980.29, representing "the reserve for unrealized profit on installment sales." It appears that the petitioner disposed of the installment sales contracts to which this amount relates in 1926, and the respondent has treated the disposition as a realization of the profit. The petitioner contends that the disposition was a part of the transaction resulting in a reorganization to which it was a party, and therefore no gain is to be recognized thereon.
*1133 These proceedings were submitted upon a stipulation, in which appears the following statement: "On December 31, 1926, petitioner was a party to a reorganization." in Jamison Coal & Coke Co., supra, we said:
* * * Stipulations can relate only to facts. We can not recognize or give effect to stipulations of law. * * *
On brief -
The respondent [contends] that the $322,980.29 represented profits which the petitioner made at the time the merchandise was sold. By virtue of Sections 212(d) and 1208 of the Revenue Act of 1928, petitioner, because it had sold on the installment plan, was given a special privilege. That privilege was the right to defer payment of taxes on the profits on installment sales until the collection of the installment payments. * * *
When the petitioner disposed of those accounts receivable it, by its own voluntary act, terminated its right to the privilege of deferment, and since it received dollar for dollar in stock and cash for those accounts receivable, the portion of such accounts representing income became realized profit to the petitioner - not a profit resulting from or coming into existence on account of the reorganization*1134 [sic], but merely the collection of a profit earned prior to that time. * * *
In Packard Cleveland Motor Co.,14 B.T.A. 118">14 B.T.A. 118, the Board held that the taxpayer realized income upon the sale of installment obligations in the taxable year. The provisions of section 44(d) of the Revenue Act of 1928 lend color to the respondent's contention, but that section of the statute is not retroactive in its effect. In Wallace Huntington,15 B.T.A. 851">15 B.T.A. 851, we held that the taxpayer realized no *540 income from the gift of installment obligations. In Virginia Beach Golf Course Annex Corp.,23 B.T.A. 1170">23 B.T.A. 1170, we held that the taxpayer realized no income from the distribution of installment obligations to its stockholders.
Charles F. Meagher,20 B.T.A. 68">20 B.T.A. 68, involved a disposition of installment obligations in an exchange of property for stock. The syllabus of that case follows:
GAIN OR LOSS - EXCHANGE - INSTALLMENT OBLIGATIONS. - Petitioner, doing business as a sole proprietor, to a large extent on the installment basis, organized a corporation to which he transferred in 1923 all of the assets of the business for all*1135 of its authorized capital stock. Included in the assets conveyed were $117,863.13 of uncollected installment obligations representing unrealized profits of $53,488.57. Held that the transfer of these installment obligations, being a transaction provided by section 202(c)(3) of the Revenue Act of 1921 not giving rise to gain or loss, respondent erred in including in petitioner's income for the year 1923 the sum of $53,488.57 as a profit realized by reason of petitioner's disposition of them in this manner.
The facts of the Meagher case clearly established a nontaxable exchange within the purview of section 202(c)(3) of the Revenue Act of 1921. In disposing of the respondent's contention that "the amount represented by the profit included in the installment obligations would escape tax", we said:
* * * that result does not necessarily follow, as this petitioner has received in the transaction stock of the corporation in exchange for the assets conveyed, and the realization as income of the value represented by the profit included in the amount of the installment obligations in question, is merely deferred until the sale by him of the stock received upon such sale, as*1136 his gain would be measured upon the basis of the cost to him of the transferred assets, which would not include the $53,488.57 of profit included in the $117,863.13 of installment obligations.
In the instant proceedings this corporate taxpayer transferred all of its assets, including the installment obligations, except $100,000 in cash, to the new corporation in exchange for $2,000,000 in cash and 14,060 shares of the new company's preferred stock of the par value of $100 per share. The Elliott-Fisher Co. paid into the new corporation the $2,000,000 of cash and received all of the new corporation's voting stock. The petitioner used a portion of the cash to retire its own preferred stock and distributed the balance of the cash and the 14,060 shares of preferred stock to its common stockholders. It does not appears that the petitioner corporation has ever been dissolved.
The petitioner contends that there was a reorganization to which it was a party and that no gain or loss is to be recognized upon the transfer of its property to the new corporation. Unlike the transfer *541 in the Meagher case, this petitioner neither transferred all of its property nor received*1137 all of the stock of the transferee. The pertinent portions of the Revenue Act of 1926 are set out in the margin. 1
*1138 The petitioner was not a party to a reorganization within the meaning of the statute. Upon the transfer, pursuant to the terms of the contract of sale, the petitioner neither transferred all of its property nor received "a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock" of the new corporation. Nor does it appear that this petitioner was ever in control of the new corporation, or that the new corporation was in control of the petitioner. Furthermore, while the transferee may be said to have acquired substantially all the properties of this petitioner, disregarding, for the moment, the petitioner's retention of $100,000 in cash, and thereby became the "corporation resulting from a reorganization", and as such is "a party to a reorganization", that does not make this petitioner "a party to a reorganization", since that term includes both corporations (transferee and transferor) only in the event that one acquires at least a majority of the voting and other stock of the other. Here, the petitioner acquired *542 only nonvoting stock in the new corporation, and that corporation acquired none of the petitioner's*1139 stock. The petitioner has not brought the transactions within the provisions of section 203(h). As the Supreme Court said in Pinellas Ice & Cold Storage Co. v. Commissioner,287 U.S. 462">287 U.S. 462, "Certainly, we think that to be within the exemption the seller must acquire an interest in the affairs of the purchasing company more definite than that incident to ownership of its short term purchase money notes." Little more than that was acquired by this petitioner, since definite provision was made in the agreement with Elliott-Fisher Co. for the retirement of the nonvoting preferred stock issued to the petitioner. See also Cortland Specialty Co. v. Commissioner, 60 Fed.(2d) 937.
The exemption provided in section 203(b)(3) relates to exchanges of property by "a corporation a party to a reorganization", and is enlarged by section 203(e) on condition that the transferee distribute the money and property received upon the exchange "in pursuance of the plan of reorganization." There is nothing in the agreement with Elliott-Fisher Co. directing the distributions that the petitioner made to its stockholders. That agreement apparently contemplated the*1140 continuance of the petitioner's corporate existence, for provision was made, and later acted upon, whereby the corporate identity of the petitioner was changed from Sundstrand Corporation to John A. Nelson Co. Furthermore, the petitioner's stockholders authorized "the sale and transfer" of its property and assets, and the distribution of the consideration "received from such sale." In these circumstances, the transaction involved can not be said to have been a nontaxable exchange of property. Cf. Howard F. Burns, Executor,28 B.T.A. 28">28 B.T.A. 28; Connecticut Power Co.,28 B.T.A. 38">28 B.T.A. 38.
The fact that the petitioner disposed of its installment obligations in a taxable transaction distinguishes this case from the Meagher case, supra, and we accordingly hold that the respondent properly determined that the petitioner realized the deferred profit upon installment obligations when it disposed of the obligations in 1926, there being nothing in the record to indicate that the petitioner did not receive the full face value of such obligations.
Reviewed by the Board.
Judgment will be entered under Rule 50.
TRAMMELL, MURDOCK, GOODRICH, LEECH and ADAMS*1141 concur in the result.
VAN FOSSAN dissents.
Footnotes
1. SEC. 203. (a) Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 202, shall be recognized, except as hereinafter provided in this section.
* * *
(b) (3) No gain or loss shall be recognized if a corporation a party to a reorganization exchanges property, in pursuance of the plan of reorganization, solely for stock or securities in another corporation a party to the reorganization.
* * *
(e) If an exchange would be within the provisions of paragraph (3) of subdivision (b) if it were not for the fact that the property received in exchange consists not only of stock or securities permitted by such paragraph to be received without the recognition of gain, but also of other property or money, then -
(1) If the corporation receiving such other property or money distributes it in pursuance of the plan of reorganization, no gain to the corporation shall be recognized from the exchange, but
(2) If the corporation receiving such other property or money does not distribute it in pursuance of the plan of reorganization, the gain, if any, to the corporation shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property so received, which is not so distributed.
* * *
(h) As used in this section and sections 201 and 204 -
(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization or (D) a mere change in identity, form, or place of organization, however effected.
(2) The term "a party to a reorganization" includes a corporation resulting from a reorganization and includes both corporations in the case of an acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation. ↩