The opinion of the court was delivered by: KNIGHT
It has been stipulated that the issues of law and fact herein be determined by this court.The action is brought, as authorized by Section 24, subd. 5 of the Judicial Code and Judiciary, 28 U.S.C.A. § 41, subd. 5, to recover taxes assessed and collected from the plaintiff by the defendant under the provisions of the Internal Revenue Act of May 29, 1928, Chap. 852, 45 Stat. 791-883, Section 101, 26 U.S.C.A. Int.Rev.Acts, page 370.
In and prior to October, 1927, the plaintiff owned 11,915 shares of stock of the Buffalo Union Furnace Company (hereinafter called Union), a corporation of the State of New York, having a par value of $100 a share. Part of this had been purchased by him and part received as dividends upon the shares so purchased.All of the stock had been held by the plaintiff more than two years prior to the aforesaid date. The Union company was re-organized pursuant to plan therefor dated October 1, 1927. In pursuance of this plan the stockholders of the Union company received in exchange for each share of $100 par value common stock in said corporation three-fifths share of common stock without par value and bonds of par or face value of $90 in said re-organized corporation. Plaintiff received for his 11,915 shares aforesaid 7,149 shares without par value of the common stock and 1,072.35 mortgage bonds, each of the par value of $1,000 in the re-organized company.
The Union company by the terms of the consolidated mortgage securing said bonds agreed to retire the bonds so secured to the amount of $112,500 principal per annum and reserved the right to pay or redeem any part thereof in excess of $112,500 per annum "on any interest day upon 30 days' notice at 105% of par, plus accrued interest up to and including October 1, 1930; 104% at par plus accrued interest during the year 1931; 103% par plus accrued interest during 1932, and 102% plus accrued interest during the remainder of the life of said bonds." The total amount par value of the bonds secured was $4,500,000.
In January, 1928, all of the stockholders of the Union company sold their stock in the corporation to the M.A. Hanna Company, and the M.A. Hanna Company, prior to November 1, 1929, sold such shares to its subsidiary, Hanna Furnace Corporation. On or about December 1, 1929, National Steel Corporation acquired from the M.A. Hanna Company the stock of the Hanna Iron Ore Company, which then owned the stock of the Hanna Furnace Corporation, which in turn owned the stock of the Union Furnace Company. In May, 1930, the name of the Buffalo Union Furnace Company was changed to Hanna Furnace Company (New York).
On or about July 24, 1930, the Commissioner of Internal Revenue, upon the audit of plaintiff's income tax return for 1928, determined that the cost of the original stock held by the plaintiff in the Buffalo Union Furnace Company, at the time of its re-organization, should be allocated to the new stock and bonds received in exchange by the plaintiff as aforesaid and allocated to the plaintiff's new stock a cost of $18.53256 per share and to his bonds a cost of $205.91748 per $1,000 bond. For the purpose of making such allocation, the Commissioner placed the market value of the stock at $90 per share and the bonds at $1,000. He then held that the gain on the stock and bonds in the re-organized company sold by the plaintiff in 1928 were capital gain, and further that any profit realized through the retirement of plaintiff's bonds was taxable as capital gain.
In accordance with the provision of the aforesaid consolidated mortgage indenture, Hanna Furnace Corporation in August, 1930, called by lot at par 109 of the Buffalo Union Furnace Company bonds, including $30,000 par value of said bonds owned by the plaintiff. On October 1, 1930, the plaintiff surrendered and delivered the aforesaid bonds, and he was paid therefor $30,000.
On or about April 9, 1931, National Steel Corporation entered into an agreement with the Manufacturers & Traders Trust Company of Buffalo, the trustee under the consolidated mortgage indenture aforesaid, for the deposit with said Trust Company of an amount in cash sufficient to pay the bondholders of two-thirds of the bonds of the Union company then outstanding, with accrued interest, and also a sufficient amount in cash to pay the remaining outstanding bonds with interest to October 1, 1931, and for the release therefrom by the Trust Company of the consolidated mortgage aforesaid together with a mortgage supplemental thereto. This arrangement was entered into at this time in order that the National Steel Corporation might give a mortgage covering the properties of the then Hanna Corporation (New York) as security in part for $40,000,000 issue of bonds then about to be executed by the National Steel Corporation. On April 10, 1931, the plaintiff joined in a notice sent to other bondholders stating that he had consented to the redemption of the bonds held by him and advising them as to the course to be taken by them in agreeing to a redemption.
On April 17, 1931, the National Steel Corporation acquired all the outstanding stock of the Hanna Furnace Corporation (New York) and on the same day the Board of Directors of the Nationl Steel Corporation adopted a resolution calling for the redemption of all of the outstanding bonds of the Union company as provided in the consolidated mortgage indenture and authorizing the Treasurer of the company "to redeem, retire and to pay the same by depositing with the trustee such amount as is necessary for that purpose." On the same day, a resolution was adopted by the Board of Directors of the Hanna Furnace Corporation, authorizing the Treasurer of that company "to redeem and retire said bonds by depositing with the Trustee such amounts necessary for that purpose and to do any and all things necessary and proper to redeem and retire said bonds and to obtain release of said mortgage."
On or about April 22, 1931, the plaintiff deposited with the Trust Company aforesaid 1,004 Buffalo Union Furnace Company bonds and took a receipt for such deposit from said Trust Company. In the months of April (commencing the 22d), May, June, July, August and September, 1931, the Hanna Furnace Company caused to be published a Notice of Redemption of the said Union company bonds, in part providing that "it is exercising the right so reserved to pay and redeem, and will pay and redeem on October 1, 1931, all of its consolidation mortgage 6% 20 year gold bonds * * * securing a total authorized issue of $4,500,000." On April 22, 1931, 4,652 of the Buffalo Union Furnace Company bonds were outstanding. On that date the National Steel Corporation, Hanna Furnace Corporation and the Manufacturers & Traders Trust Company made a supplementary agreement for the redemption of the outstanding bonds. On April 28, 1931, in pursuance of the agreement, the National Steel Corporation paid to the Trust Company the sum of $4,317,796, being 104% of the par value of the 4,110 Buffalo Union Furnace Company consolidated mortgage bonds, with accrued interest to April 28, 1931, on 3,128 of said bonds theretofore deposited with said Trust Company and interest to October 1, 1931, on 982 bonds not deposited. Included in said 3,128 were the bonds of the plaintiff. The Trust Company delivered to the National Steel a satisfaction and discharge of the consolidated mortgage. National Steel Corporation charged the Hanna Furnace Corporation (New York) with the sum of $4,162,000, being par value of the Buffalo Union Furnace Company bonds then outstanding and interest paid. The Steel Company charged $166,480 balance of the money paid on the bonds to its own surplus account. On April 28, 1931, the Trust Company credited the sum of $1,048,678 to the plaintiff's checking account. This was in sum of $1,044,160 on account of said bonds and $4,518 on account of interest to April 28, 1931. Plaintiff then surrendered his trust receipt evidence of deposit of bonds. From time to time subsequent to April, 1931, and prior to October, 1931, various holders of the stock delivered bonds to the Trust Company and received payment at rate fixed, and all of the bonds were delivered to the Trust Company and paid by October 1, 1931.
The plaintiff made return for income for years 1930 and 1931 and paid the Collector $8,324.36 for the year 1930, and $73,867.64 for the year 1931. Plaintiff's profits on the Buffalo Union Furnace Company bonds to 1930 amounted to $23,823.49 and for 1931, $837,418.85. The plaintiff reported these profits as capital gains and so computed them in his return. The Commissioner of Internal Revenue assessed against the plaintiff an additional income tax of $13,056, with $2,502.10 interest, for the year 1930, and $79,840.82 with $10,510.55 interest for the year 1931. This assessment was paid, and this suit is brought to recover the additional tax so paid.
The first contention of the plaintiff is that the grins in question were impressed with the character of capital gains when the exchange of the original stock was made and that they retained that character thereafter; that the effect of the re-organization provisions of the statute were to postpone taxation of the capital gain on the 1927 exchange. This contention presents a question, so far as I am advised, that has not been passed upon by the courts. It seems to me, however, that it can not be sustained.
The Revenue Act of 1928, Chapter 852, 45 Stat. 791, section 22(e), 26 U.S.C.A. Int.Rev.Acts, page 356, provides: "In the case of a sale or other disposition of property, the gain or loss shall be computed as provided in sections 111, 112, and 113." The last-mentioned sections fix the method determining the amount of the gain, and section 111(a) reads: "The gain from the sale or other disposition of property shall be the excess of the amount realized therefrom over the basis provided in section 113," 26 U.S.C.A. Int.Rev.Acts, page 376, and such basis is the original cost of the bonds as allocated to the bonds in re-organization. Bonds clearly are property. Definitely the sale or other disposition of them was made in 1930 and 1931, and the government has taxed the amount realized over the basis of value fixed in the re-organization. The basis of each bond in re-organization was fixed by the Commissioner. In arriving at this he made an estimated par or full value of each bond as $1,000. No gain was then realized, and the question whether there would be any gain was not then known. A loss might have been realized. This awaited the time of redemption or other disposition. The basis was fixed to determine later gains or lesses and not to preserve the right to capital gain.
"Capital gain" as defined by Revenue Act of 1926 section 208(a), 26 U.S.C.A. Int.Rev.Acts, page 157 and by Section 101(c), Act of 1928, 26 U.S.C.A. Int.Rev.Acts, page 371, means taxable gain from the sale or exchange of capital assets consummated after December 31, 1921. Section 203(a) of the Act of 1926, 25 U.S.C.A. Int.Rev.Acts, page 148, provides, with certain exceptions, that upon the sale or exchange of property the entire amount of gain or loss as determined under section 202, 26 U.S.C.A. Int.Rev.Acts, page 147, shall be recognized. One of such exceptions arises in an exchange in re-organization. Section 203(b) (2). The purpose served by this exception are two -- to relieve re-organization from premature taxation and to prevent taking of losses by wash sales. C.H. Mead Coal Co. v. Commissioner, 4 Cir., 72 ...