Appeal from the United States Board of Tax Appeals.
Before MANTON, AUGUSTUS N. HAND, and CHASE, Circuit Judges.
AUGUSTUS N. HAND, Circuit Judge.
The government's claim to additional income taxes found to be due, is based on a sale by the Securities Company in 1924 of 3,000 shares of stock of the Missouri Pacific Railroad Company. Clinchfield Securities Company is assessed a part of the additional tax because, being a wholly owned subsidiary of the Securities Company, the two companies filed a consolidated return for 1924. If any additional tax is due, there is no objection to the division of the tax between the companies.
The stock of the Missouri Pacific Railroad Company that was sold by the taxpayer in 1924 was acquired in 1917 upon a reorganization of the old Missouri Pacific Railway by means of the usual foreclosure sale employed in such cases. Under the terms of the plan and agreement of reorganization, the stockholders of the old company, by depositing their old stock and paying $50 per share, were entitled to receive common stock of the Missouri Pacific Railroad Company, which had acquired the assets of the old corporation, of the same par value and general mortgage 4 per cent. bonds of the new company in principal amount equal to the cash paid. Pursuant to the plan, 25 per cent. of the payment was made by the taxpayer on May 22, 1917, and the remaining 75 per cent. with interest from May 22 was paid on August 22, 1917, after which the new securities were delivered.
The petitioners, in their returns, claimed a deductible loss of $40,882.50 on the sale. The respondent disallowed this claim and determined that a profit resulted from such sale in the amount of $10,117.50. The Board of Tax Appeals determined that there was a taxable profit on the sale of $8,617.50 calculated as follows:
Selling price of 3,000 shares of Missouri
Pacific Railroad stock in 1924 $94,117.50
Market value of such stock on August 22,
It is to be noticed that the Board of Tax Appeals held that a taxable profit was realized in 1924 and that it was based upon the difference between the value of the new stock when issued in 1917 and the greater sum obtained upon the sale.
The issues before us make it necessary to state the cost and dates of acquisition of the stock of the old company so far as the shares were found by the Board of Tax Appeals to have been involved in the reorganization and the sale of the new stock in 1924. In 1909 the Securities Company purchased 3,000 shares of stock of the old company at a cost of $211,106.25. The value of these 3,000 shares on March 1, 1913, was $113,500. On June 11, 1913, they purchased 1,000 shares of the old company at a cost of $26,125. In 1924 they sold 3,000 shares of the new stock for $94,117.50 as we have already stated.
The government contends that, when the sale of 3,000 shares of the new stock was made in 1924, gain or loss was realized measured by the difference between the market value of the stock on August 22, 1917, when issued to the taxpayer, and the amount of the selling price. In other words, the argument is that the issue of the new stock was a closed transaction and had no relation to the cost or value of the old stock for purposes of determining gain or loss in 1924. But the taxpayer calls attention to section 203(b)(2) of the Revenue Act of 1924, 26 USCA § 934(b)(2), which provides that:
"(2) No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization."
It argues that the foregoing clause applies to the present case and nullifies the calculation of a gain based upon the difference between the value of the stock when issued and the amount realized when it was sold. The government, however, seeks to avoid the application of the clause. It says that the stock of the old company was not exchanged "solely for stock or securities" of the new company, but that the old stock and cash, upon payment of which the taxpayer was permitted to participate in the reorganization, were so exchanged. Yet the payment of cash did not take the transaction out of section 203(b)(2), for the word "solely" is aimed at what is received in exchange and not at what is handed over in order to secure participation in a reorganization. Section 203(b)(2) was designed to prevent persons who participate in a reorganization from receiving a distribution of corporate assets without being subjected to a profits tax when a profit has been realized. If such distribution were made, gain is recognized under section 203(d)(1), 26 USCA § 934(d)(1), to the extent of the distribution.
As we said in Cortland Specialty Co. v. Commissioner, 60 F.2d 937, at page 939, "Reorganization in the most ordinary sense suggests 'the formation of a new corporation * * * for the purpose of purchasing the company's works and other property, after the foreclosure of a mortgage or judicial sale,'" and again at page 940 referring to the Revenue Act of 1926, "Its purpose was to relieve those interested in corporations from profits taxes in cases where there was only a change in the corporate form in which business was conducted without an actual realization of any gain from an exchange of properties."
While, strictly speaking, the payment of $50 per share was not an assessment, but a voluntary payment made for the privilege of participating in the reorganization, that fact did not deprive the taxpayer of the right to invoke section 203(b)(2). In De Blois v. Commissioner (C.C.A.) 36 F.2d 11, a similar payment made by a stockholder in order that he might participate in a reorganization, was held to show an election on his part not to claim a loss under section 202(a) of the Revenue Act of 1918 (40 Stat. 1060), and to bring him under section 202(b) of that act relating to reorganization. To be sure, the word "solely" did not appear in section 202(b) of the Revenue Act of 1918, but, as we have already said, that word in the act of 1924 applied only to the securities received in exchange and not to the property handed over under the plan of reorganization. We conclude that the Board of Tax Appeals erred in holding that section 203(b)(2) did not apply to this case, and that the exchange in 1917 was a closed transaction whereby a profit was realized in 1924 to the extent of the excess of the selling price over the value of the new stock received on August 22, 1917.
The mode of computing gain or loss where securities are received, in pursuance of a plan of reorganization in exchange for stock and cash handed over by the reorganized corporation, and are afterwards sold, is governed by section 204(a), section 204(a) (6), and section 204(b) of the Revenue Act of 1924, 26 USCA § 935(a)(6), (b), read in connection with section 203(b) already mentioned, and section 202(a) and (b) of that act, 26 USCA § 933(a) and note. The portions of section 204(a), section 204(a)(6) and section 204(b) that are applicable to the facts of this case are as follows:
Sec. 204(a). "The basis for determining the gain or loss from the sale * * * of property acquired after February 28, 1913, shall be the cost of such property; except that -- * * *
"(6) If the property was acquired upon an exchange described in subdivision (b) * * * of section 934 , the basis shall be the same as in the case of the property exchanged, * * * increased in the amount of gain or decreased in the amount of loss to the taxpayer that was recognized upon such ...