*2262 The Ault & Wiborg Co. sold a portion of its plant in 1920, receiving in exchange therefor $2,000,000 in cash and 5,000 shares of stock in a corporation organized to operate the properties sold. Held that the 5,000 shares of stock did not have any fair market value when received by the Ault & Wiborg Co.
*666 These proceedings were consolidated for hearing and decision and involve alleged deficiencies in income and profits taxes for the calendar year 1920 as follows:
| Ault & Wiborg Co. of New York | $10,092.10 |
| Ault & Wiborg Co | 241,073.42 |
| Ault & Wiborg Co. of Uruguay | 565.38 |
The petitioners allege that the respondent erred in holding that certain shares of stock received by the Ault & Wiborg Co. on July 1, 1920, when it sold a portion of its business, had a fair market value and that such fair market value was equal to the par value of the stock.
FINDINGS OF FACT.
The Ault & Wiborg Co. is an Ohio corporation with principal office at Cincinnati. It was organized in*2263 1891 as the successor to the partnership of Ault & Wiborg, which was formed in 1878. The principal business of the partnership as continued by the corporation has been the manufacture and sale of printing and lithographing inks, with other incidental lines including the manufacture of varnishes, typewriter ribbons and carbon paper. The business started in a small way with annual sales of a few thousand dollars and gradually developed into a business with sales amounting to five or six millions of dollars at the beginning of the World War.
The products manufactured by the Ault & Wiborg Co. received a world wide distribution. Its business activities were carried out through the following subsidiary corporations:
Ault & Wiborg Co. of New York,
Ault & Wiborg Co. of Uruguay,
Ault & Wiborg Co. of Burffalo,
Ault & Wiborg Co. of Argentine,
Ault & Wiborg Co. of Brazil,
Ault & Wiborg Co. of Shanghai,
Queen City Varnish Co.
The Ault & Wiborg Co. and its subsidiaries did the largest printing-ink business of any house in the world. Printing and lithographing inks are manufactured by the combining of color pigments with ink varnishes and oils. The color pigments are derived*2264 from dyes and intermediates. With the exception of black inks and some blues, the dyes and intermediates used in the manufacture of the inks produced by the Ault & Wiborg Co. were all imported from Germany, prior to the World War. After the declaration of war in 1914 these products could no longer be obtained from Germany and all of these materials available in this country were purchased. The quantity so obtained lasted for about one year. The cutting-off of the source of supply for these materials made it necessary for the Ault & Wiborg Co., if it was to continue in business, to obtain such *667 materials from another source. As the stock of a particular material began to run low chemists were employed and instructed to find a substitute. No chemists were available in this country experienced in dye making. As the situation became more acute, additional chemists were employed, until a total of 65 were finally engaged in experimental work looking to the discovery of substitutes that could be used during the continuation of the war. The permanent establishment of a dye and chemical business was not contemplated, but as necessity demanded and without any preconceived*2265 plan buildings were erected and machinery installed to carry on this new activity. Following a grandual growth from 1916 a complete dye and chemical plant of some forty buildings was erected. This plant, which employed about 500 men, was operated 24 hours a day for seven days a week.
Because of the lack of experience in the dye-making business, there were many accidents and explosions. Buildings were destroyed, several men were killed and many were injured, all of which caused great anxiety and worry on the part of the company's officers.
The dye and chemical branch of the business was run as a separate financial proposition and as a department of the company's business. It not being advantageous as an economic proposition to manufacture the limited quantities of the various dyes and chemicals used by the company in its business, large quantities were manufactured and the surplus sold. The operations of this branch of the business resulted as follows:
| 1916, loss | $226,120.75 |
| 1917, loss | 311,851.01 |
| 1918, loss | 217,326.62 |
| 1919, loss | 273,935.68 |
| 1,029,234.06 | |
| 1920, profit | 200,494.63 |
| Net loss for period | 828,739.43 |
Sometime in January or early February, *2266 1920, the Ault & Wiborg Co. was visited by the representatives of three Swiss companies engaged in the dye business in Basle, Switzerland, who were considering the buying of a plant in the United States. They examined the Ault & Wiborg Co.'s plant and, after a complete survey and report had been made by three chemical engineers brought with them from Switzerland, negotiations for its purchase were started. Starting with an original price of either $3,000,000 or $3,500,000 the negotiations continued by correspondence and conferences. Finally, as an ultimate figure the prospective seller asked $2,500,000 cash. However, the representatives of the Swiss companies finally said that *668 the very most that they would give was $2,000,000 in cash and $500,000 par value of stock in a corporation to be organized in this country to operate the plant.
German dyes were then being brought into this country and the Ault & Wiborg Co. realized that it was not as proficient in the dye-making business as the Germans, who originated all the processes, and that it could not hope to compete successfully with the German dyes. Furthermore, its president, L. A. Ault, was discouraged with the*2267 business because of its hazards, the maiming and killing of empolyees at the plant, and the anxiety to which he was subjected in the matter. These factors prompted the acceptance of the offer made by the Swiss companies and the execution of an agreement to sell on April 28, 1920.
This agreement, after describing the Ault & Wiborg Co. as the "Seller" and the three Swiss companies as the "Purchasers," provided in part as follows:
WITNESSETH, that the Seller agrees to sell and convey and the Purchasers agree to purchase the property described as follows:
The purchase price is Two Million Five Hundred Thousand ($2,500,000) Dollars payable as follows:
Five Hundred Thousand ($500,000.00) Dollars in cash, certified check or bank draft, on the execution of this agreement, to be delivered to the Seller by the Purchasers, or by their duly accredited bankers or representatives in the United States, upon delivery to the Purchasers or their said representatives of this contract properly executed by the Seller, which said Five Hundred Thousand ($500,000) Dollars shall bear interest at the rate of (6%) six per cent per annum, and which interest shall be credited on account of the purchase*2268 price to the Purchasers or their assigns at the time of closing of title, as hereinafter provided.
Five Hundred Thousand ($500,000.00) Dollars by the delivery to the Seller of common stock of the par value of said amount, in a corporation to be organized by the Purchasers under the laws of some State of the United States, with an authorized capital stock of Two Million Five Hundred Thousand ($2,500,000.00) Dollars, all of which stock shall be common stock, and the par value of each share shall be One Hundred (100.00) Dollars, it being understood that all the stock issued by the said proposed corporation on or before July 1st, 1920, shall be issued for cash only and paid for at par, except Five Hundred Thousand ($500,000.00) Dollars in stock of the said Company to be issued to the Seller, as hereinbefore provided.
The balance of the purchase price in cash, certified check, or bank draft, on or before July 1st, 1920.
The purchasers objected strenuously to the $500,000 down payment on April 28, 1920, as called for by the agreement of that date. This, however, was insisted upon by the seller, inasmuch as a slump in the dye business had started, which, together with the hazards*2269 of the business and the worry it caused, made the company desire assurance that the agreement would be carried out and the business definitely disposed of. Between April 28, 1920, and July 1, 1920, *669 the slump on the dye branch of the business materially increased, as German dyes were then being brought in.
Prior to July 1, 1920, the corporation provided for by the agreement of April 28, 1920, was organized by the Swiss companies, under the name of The Cincinnati Chemical Works, Inc. This corporation had an authorized capital stock of $2,500,000 consisting of 25,000 shares of common stock.
The agreement of April 28, 1920, was carried out on July 1, 1920, when certain agreements were executed and the Ault & Wiborg Co. received $1,500,000 cash and 5,000 shares of the common stock of the Cincinnati Chemical Works, Inc., having a par value of $100 per share, in exchange for assets worth approximately $1,700,000.
On July 1, 1920, a sales agreement was executed, which after describing the Ault & Wiborg Co. as party of the first part, and the Cincinnati Chemical Works, Inc., as the successor in interest and assignee of the three Swiss corporations, as party of the second*2270 part, provided in part as follows:
(6) The party of the first part agrees to deliver to the assignors of the party of the second part, simultaneously herewith, an agreement providing for an option on the Five thousand (5,000) shares of Capital Stock of the party of the second part, and for the making effective said option, which agreement is to be approved by counsel for the respective parties, and the party of the second part will thereupon arrange for the endorsement as provided in said option agreement of the certificate of stock and the registration thereof with the Transfer Agent of the party of the second part at New York, and will deliver said certificate of the said shares of stock to the party of the first part on or at the time of the carrying out of the other provisions of this agreement.
A second agreement was executed on July 1, 1920, under the terms of which the three Swiss companies acquired an option to purchase the 5,000 shares of stock at any time within 10 years.
The Ault & Wiborg Co. considered the 5,000 shares of stock of the Cincinnati Chemical Works, Inc., of a very questionable value and set them up on its books on July 1, 1920, at a value of $1. In*2271 its return for the year 1920 there was reported a profit of $233,759.75 from the sale computed as follows:
| Received in cash | $2,000,000.00 |
| Received in stock (par value $500,000) fair market value | 1.00 |
| Total received | 2,000,001.00 |
| Depreciated value of assets sold | 1,766,241.25 |
| Profit reported | 233,759.75 |
In the computation of the deficiencies the respondent has determined that the 5,000 shares of stock had a fair market value equal to their par value, or $500,000, and has increased the profit reported by $499,999.
*670 The only properties owned by the Cincinnati Chemical Works, Inc., were those acquired from the Ault & Woborg Co. It had no working capital. It was necessary for it immediately to borrow money with which to begin business, and did borrow $200,000 from a Cincinnati bank. This loan was made by the bank without hesitation, although unaccompanied by security. A total of $1,600,000 was borrowed during the first year upon the guaranty of the three Swiss companies and against trade acceptances. The Swiss companies also advanced $1,507,000 prior to July 1, 1921, $1,000,000 of which was used to pay off bank loans.
Subsequent operations of*2272 the dye and chemical business, sold to the Cincinnati Chemical Works, Inc., have resulted as follows:
| Year ended | Profit | Loss |
| June 30, 1921 | $590,090.46 | |
| June 30, 1922 | 625,802.69 | |
| June 30, 1923 | $152,418.40 | |
| Sept. 30, 1923 | 43,758.22 | |
| Sept. 30, 1924 | 815,018.84 | |
| Sept. 30, 1925 | 140,692.57 | |
| Sept. 30, 1926 | 79,822.23 | |
| Sept. 30, 1927 | 36,852.02 | |
| Sept. 30, 1928 | 82,448.25 | |
| Total | 492,233.47 | 2,074,670.21 |
| Loss for period | 1,582,436.74 |
On October 1, 1923, the capital stock of the Cincinnati Chemical Works, Inc., was reduced by 68 per cent, or $1,700,000, and the accumulated deficit of more than $1,000,000 eliminated. At that time the Ault & Wiborg Co. turned in its certificates for 5,000 shares and received a new certificate for 1,600 shares, which were sold in February, 1928, for $60,000.
The dye industry in the United States started as the result of the emergency created by the World War, which shut off the supply of German dyes and chemicals and on July 1, 1920, it was an infant industry untried by the return of German competition.
In 1920 money conditions were bad. The securities market was dull. It was difficult to sell securities and the*2273 better class of securities were selling at a low price.
The 5,000 shares of stock of the Cincinnati Chemical Works, Inc., received by the Ault & Wiborg Co. on July 1, 1920, had no value as security for a loan and they had no fair market value on that date.
OPINION.
SMITH: The only issue involved in these proceedings is whether or not the 5,000 shares of stock in the Cincinnati Chemical Works, Inc., received by the Ault & Wiborg Co. on July 1, 1920, had any fair market value at that date, the petitioners having waived certain *671 allegations of error relating to, first, the reduction of cost by the amount of accumulated depreciation in computing the gain or loss resulting from the sale of the dye and chemical branch of the business, and, second, the computation of the tax liability of the Ault & Wiborg Co. under the provisions of section 328 of the Revenue Act of 1918.
Section 202(b) of the Revenue Act of 1918 provides in part as follows:
When property is exchanged for other property, the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any * * *.
*2274 Consequently it appears that if the 5,000 shares of stock of the Cincinnati Chemical Works, Inc., received by the Ault & Wiborg Co. on July 1, 1920, had no fair market value on that date, the respondent erred in including the par value of such stock in the taxable income of the Ault & Wiborg Co. for the year 1920 and in proposing to assess proportionate parts of any deficiency occasioned thereby against the petitioners.
From the record it appears that prior to 1914 Germany was the source of supply for essential dyes and chemicals employed in the business of the petitioners and that as an incident of the World War it became necessary for the business to develop its own source of supply within the United States. This was done by the establishment of a dye and chemical branch of the Ault & Wiborg Co. at considerable expense, the operations of which, up until the year 1920, entailed heavy losses. Subsequent to the termination of the World War and beginning in the year 1920 dyes and chemicals manufactured in Germany again appeared in the United States markets and it became apparent to the petitioners that continued operation of the dye and chemical branch of the business would result*2275 in further heavy losses. That this was a reasonable anticipation is borne out by the results of the operations of the Cincinnati Chemical Works, Inc., as set forth in the findings of fact. Furthermore, in 1920 the United States was passing through a period of deflation and financial depression with the result that it was difficult to sell securities. Cf. .
It was admitted that the valuation of $500,000 placed upon the 5,000 shares of stock of the Cincinnati Chemical Works, Inc., by the respondent was arbitrary. It was argued on his behalf, however, that the Cincinnati Chemical Works, Inc., had no difficulty in establishing bank connections in Cincinnati and was enabled immediately after incorporation to borrow, without security and without the guarantee of its stockholders, the sum of $200,000 with which to commence operations. In this connection, however, it need only be *672 pointed out that the Cincinnati Chemical Works, Inc., owned unencumbered assets worth approximately $1,700,000 and that at the time it borrowed the $200,000 it had made no prior loans, and it is also significant that within the first year of its experience*2276 it became necessary for it to borrow sums approximately equal to the value of its assets. Under such circumstances we do not believe that the fact that the Cincinnati Chemical Works, Inc., was able to borrow $200,000 without security would indicate that its stock was worth par. It is clear that the dye-making industry in the United States in 1920 was yet in its infancy and the action of the three Swiss companies in purchasing the dye and chemical branch of the business of the petitioners reasonably may be regarded as speculative.
The petitioners presented the testimony of one of the vice presidents of a bank in Cincinnati, Ohio. This witness, with a background of more than twenty years banking experience and thoroughly familiar with business conditions in and around Cincinnati before and on July 1, 1920, and who had acquired first-hand knowledge of the financial structure and condition of the Cincinnati Chemical Works, Inc., as the result of negotiations through him by that company for a loan with which to start business, testified in part as follows:
Q. And in your opinion did the stock of the Cincinnati Chemical Works at the time, in 1920, have a fair market value?
A. *2277 I do not think we felt qualified to express an opinion; we looked upon it as a hazardous enterprise, as we had no idea what the effect of the opening up of imports from Germany would have; we felt rather relieved that he had sold that end of the business; we were glad that the industry would continue for Cincinnati, but as far as placing a value upon the common stock was concerned, we felt that it was in the "lap of the Gods" - utterly impossible to place any value on it from our point of view.
Q. In other words, you might consider it had a speculative value?
A. Entirely speculative; if that is a fair word for it.Q. Well, would you consider that that stock had any value as collateral for a loan?
A. None whatever. Q. In 1920 you are speaking of, of course? A. Yes.The petitioners also presented as a witness Irvin F. Westheimer, a resident of Cincinnati, who has been engaged in business since 1916 and is a member of the New York and Cincinnati Stock Exchanges, as well as a member of the firm of Westheimer & Co., stock and bond brokers and dealers in securities, maintaining offices in Cincinnati and Dayton, Ohio, Baltimore, Md., and Washington, D.C. He testified*2278 that the year 1920 was a period of very severe depression in the stock and bond business, commonly termed a panicky condition; that money conditions were very bad, that the securities market *673 was very dull, that it was extremely difficult to sell securities, and that the better class of securities was selling at a very low price. He further testified that in his opinion the stock of the Cincinnati Chemical Works, had absolutely no market value, that he would have absolutely refused to underwrite the stock issue of such a corporation and that he was confident that no reputable concern would have underwritten such a stock issue.
In his testimony appears the following question and answer:
Q. According to the evidence this is tangible property, principally tangible property; the cost to Ault & Wiborg Company, approximately one million seven hundred thousand dollars; now, the ownership of that property is represented by two million five hundred thousand dollars par value of the stock of the Cincinnati Chemical Works. Would it be your opinion that upon that showing alone that the stock of the Cincinnati Chemical Company had no fair market value, taking into consideration*2279 also the fact that new owners were coming in, apparently experienced chemical men?
A. If we were - if we had submitted to us a company that for four years had shown losses running from $200,000 to $300,000 a year, and then during the year of the sale should show a probable profit which they may have been able to show on July 1st - I do not know whether they could or not - the year of 1920 showed a profit of $200,000 - I do not know what six months would have shown at that time, that even had they shown a profit of $100,000 or $200,000 to July 1st, with all of the circumstances that surrounded this branch of the Ault and Wiborg Company, I should say that stock would have absolutely no market value. Here is a company that shows constant losses; it is an industry created through most unusual circumstances - a World War - that has cut off the natural supply of the product that they were manufacturing. It was simply a matter of time until the old source of supplies would again begin to function, and if this company lost money steadily while the old sources of supply were cut off, I should say that the probability of their making money when the old sources of supply again began to*2280 flow was rather remote, and so far as three companies joining together - three very large and successful foreign companies joining together to start a company in the United States of America, I should say that the likelihood of their success was a gamble. We would not care to participate any in the flotation of their issue. Here is a company they are organizing without a dollar of working capital; it means there would have to be prior securities issued, prior loans, which would cover all of the value of that plant if it continued to operate as it had in the past, and any specified value that there might have been to that plant, under the hammer, perhaps would more than be eaten up by the prior issue, such as bank loans, preferred stock, note issues, bond issues, and there would have been nothing for the common stock. The value of a common stock is its earning power. I can cite to you Fleischmann stock which is a Cincinnati concern primarily, with a very small market value selling around a high price many many times its book value; it is selling on its earning power. I can name to you railroads that have very high book value and that earn very little money and that are selling*2281 at a very low price. The value of a common stock is the earning power of the corporation, and the earning power of this corporation was in red. I should say absolutely it had no market value. So far as these three foreign companies joining together, I should say that three would be very much weaker than one; what is everybody's job is nobody's job, and they would have to demonstrate to me their ability *674 to make dyes and chemicals in the United States before we would be willing to put our name to a security of that nature. Its records were bad and its prospects were bad. I should say it had no market value whatsoever. We would not have bought the stock under any consideration, except upon instructions from the purchaser that came to us.
We are aware of the difficulties presented by proceedings before us involving valuations and we have indicated in numerous decisions that no set formula or rule can be employed in determining what a certain thing was worth at a given date or in determining whether or not it had a fair market value on that date. In *2282 , we said:
The determination of fair market value is largely a matter of judgment and various theories of valuation are useful only in so far as they support a result that comports with sound judgment.
In , we said:
* * * The Board and its members do not have, and are not expected to have, peculiarly expert knowledge upon the value of securities or any other of the multitudinous questions of fact which arise in the vast number of cases before it. It can only decide the issues in any case by giving judicial consideration to the evidence properly in the record. Such evidence is not to be regarded, as expressed by respondent's counsel, as an "assistance" to the Board in discharging a duty imposed upon it, but as the proof and substantiation by the parties of the positions which they respectively present for adjudication. The function of the Board should not be confused with that of the Commissioner of Internal Revenue. The Commissioner's determinations are in aid of his administrative duty to see that taxes imposed are assessed and collected, and there are no methods prescribed for*2283 the ascertainment of the facts upon which such administrative determination must be based. The Board is outside this organization with a duty to hear and decide as between the taxpayer and the Commissioner upon a record publicly made in accordance with rules of evidence and procedure and subject only to appellate review by the courts of appeal. Aside from general matters well recognized as subject to judicial notice, it has in any proceeding no official knowledge except as gathered from the evidence therein, and its decision must reflect the preponderance of such evidence. To the extent that presumptions are considered, it is not because the Board chooses to employ them but because they are established in the law. We approach the problem of value, therefore, not as experts with the aid of the parties, but to judge impartially of the issue between conflicting interests, in the light of all the evidence.
In view of the foregoing, we are convinced from the record in this case that the 5,000 shares of stock of the Cincinnati Chemical Works, Inc., received by the Ault & Wiborg Co. on July 1, 1920, did not have a fair market value and that the $499,999 included by the respondent in*2284 the taxable income of the Ault & Wiborg Co. for the year 1920 should be excluded therefrom.
Reviewed by the Board.
Judgment will be entered under Rule 50.
MARQUETTE and STERNHAGEN dissent.