1 T.C. 80">*80 Petitioner seeks a redetermination of deficiencies in its income and excess profits tax for the year 1937 in the amounts of $ 1,255.11 and $ 426, respectively.

1 T.C. 80">*81 The only question presented for our determination is whether petitioner, having purchased shares of its own stock in 1935, realized taxable income in 1937 when it sold such stock at a price in excess of that paid.

FINDINGS OF FACT.

The stipulated facts, which are hereby found as stipulated, together with evidence adduced at the hearing, disclose the following:

Petitioner is a Mississippi corporation, with its principal office in Dallas, Texas. Its Federal income tax return for the year in question was filed with the1942 U.S. Tax Ct. LEXIS 35">*36 collector of internal revenue at Jackson, Mississippi.

Prior to September 20, 1935, petitioner's authorized and outstanding capital stock consisted of 500 shares of common stock of a par value of $ 100 each.

J. H. Neville and others associated with him owned a controlling interest consisting of 260 shares; Alvyn A. Hungerford owned 140 shares; Tracy-Locke-Dawson, Inc., a corporation, and others associated with it owned the remaining 100 shares, which were acquired for machinery transferred to petitioner. In September 1935 the Tracy-Locke-Dawson group acquired an additional 125 shares of petitioner's stock from Neville for $ 50 a share. At the same time Hungerford acquired enough shares to raise his holdings to 225 and petitioner acquired 50 shares of Neville's stock, having purchased 64 shares at $ 50 per share and immediately resold 14 of those shares to one Howell Robins, who was a member of the Tracy-Locke-Dawson group.

This redistribution of stock interests at that time was due to Neville's insistence upon coming into the company on an active basis when it was felt that petitioner did not have need for his services. It was also felt that his active participation might not be1942 U.S. Tax Ct. LEXIS 35">*37 satisfactory because of personal differences. This readjustment of stock interests left the Tracy-Locke-Dawson group and Hungerford with equal stockholdings. This was arranged in order that no one would have control, and it was understood and agreed that this would be a permanent arrangement.

The extra 50 shares of stock were not purchased by the two interests because Hungerford was not able to raise any more money.

At the time petitioner acquired from Neville the 50 shares in question, the certificates evidencing the shares were marked "Canceled and charged to treasury stock," and reattached to the stubs in the certificate book from which they had been taken.

The transaction was reflected on the ledger of the corporation by a net debit of $ 5,000 to an account headed "Treasury stock." The corporation's balance sheet as of September 30, 1935, and as of December 1 T.C. 80">*82 31, 1936, did not carry any "Treasury stock" as an asset. Its outstanding capital stock was there listed as $ 45,000.

Petitioner's business for 1936 was profitable, the profit being estimated in September, which was the end of its season, at approximately $ 18,000. In that year, by reason of the Federal tax levied1942 U.S. Tax Ct. LEXIS 35">*38 on the undistributed profits of corporations, petitioner anticipated a potential tax liability of approximately $ 3,000 if it did not fully distribute its earnings. To meet this situation petitioner considered an issuance of preferred stock of 3,600 shares at $ 5 per share. Its officers discussed the matter with its attorneys and an amendment to effect it was prepared. Before the plan was consummated Hungerford advised Locke that it would be necessary for Hungerford to sell out his interest in the business and move to Florida for his health. As a result of negotiations which followed, the Tracy-Locke-Dawson group acquired the Hungerford 225 shares for $ 182.22 per share and abandoned the preferred stock plan. A loan of $ 18,000 was secured by money borrowed on personal endorsements of the interested parties, and, to avoid the undistributed profits tax, a dividend was declared in that amount. The cash resulting from net operating profits was used for the purchase of equipment.

To obtain the money to repay the bank loan, petitioner secured from the stockholders $ 9,000 of the dividend distributed, plus $ 4,000 in addition, and on January 5, 1937, issued to them 37 shares of its1942 U.S. Tax Ct. LEXIS 35">*39 stock, which it credited to the treasury stock. The stock was issued at $ 182.22 a share or a total of $ 6,742.14.

In September 1937 the estimated profits were about the same as for 1936, the undistributed profits tax law was still in effect, and petitioner required additional equipment calling for an expenditure of $ 15,000. It was then determined to increase petitioner's capital stock by 500 shares. On October 30, 1937, a charter amendment was filed with the Secretary of State for the State of Mississippi, increasing the authorized capital stock by an additional 500 shares of common stock at a par value of $ 100 each, and the increase was entered on petitioner's books, in its unissued stock ledger and authorized stock ledger accounts.

On September 30, 1937, 179 shares of petitioner's stock were issued at a price of $ 200 per share, of which 166 were out of the newly authorized stock and the remaining 13 were out of the treasury stock account. The 13 shares thus issued completely disposed of the 50 shares of treasury stock acquired by petitioner in 1935. When the 50 shares of stock were sold in 1937, the stubs in petitioner's stock certificate book under the caption "from whom1942 U.S. Tax Ct. LEXIS 35">*40 transferred" were marked "Treasury stock," and the "Treasury stock" account was credited in full and closed out.

1 T.C. 80">*83 The $ 6,842.14 difference between the price paid for the 50 shares of stock in question and the price at which they were reissued was originally credited by petitioner to an account denominated "Premium sale of treasury stock." At some unknown later date the word "Treasury" was scratched out, and the word "Capital" written into the caption of the account in pencil. At the close of the year 1937 petitioner debited the last mentioned account for an amount which included the profit on the sale of the treasury stock, and credited its surplus account for an amount which included the gain from the sale of the treasury stock.

OPINION.

It is by now established that under the 1936 and subsequent revenue acts treatment of a corporation's dealings in its own stock is validly prescribed by respondent's amended regulations. The construction of that regulation, however, creates the present problem. It reads as follows:

Art. 22 (a)-16. [Regulations 94.] Acquisition or disposition by a corporation of its own capital stock. -- Whether the acquisition or disposition by a1942 U.S. Tax Ct. LEXIS 35">*41 corporation of shares of its own capital stock gives rise to taxable gain or deductible loss depends upon the real nature of the transaction, which is to be ascertained from all its facts and circumstances. The receipt by a corporation of the subscription price of shares of its capital stock upon their original issuance gives rise to neither taxable gain nor deductible loss, whether the subscription or issue price be in excess of, or less than, the par or stated value of such stock.

But if a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another. So also if the corporation receives its own stock as consideration upon the sale of property by it, or in satisfaction of indebtedness to it, the gain or loss resulting is to be computed in the same manner as though the payment had been made in any other property. Any gain derived from such transactions is subject to tax, and any loss sustained is allowable as a deduction where permitted by the provisions of the Act.

The regulation was obviously derived from statements in ;1942 U.S. Tax Ct. LEXIS 35">*42 certiorari denied, . In addition to the language incorporated in the regulation in practically the same words, that opinion also asserted: "If it was in fact a capital transaction, i. e., if the shares were acquired or parted with in connection with a readjustment of the capital structure of the corporation, the Board rule [that no gain or loss results] applies." It is not unreasonable to assume that this concept also inheres by inference in the regulation.

The reported cases dealing with the question under the amended regulations are uniform in concluding that taxable gain was the consequence of the respective situations there considered. But we do not think it follows that the existence of circumstances authorizing a contrary 1 T.C. 80">*84 result is impossible or that, if such circumstances arise, the corporation must nevertheless be treated as having secured a taxable gain. The opinion in each case considers and discusses the question, although ultimately rejecting the result on its own facts, and indeed such a principle would contradict the alternative character of the regulation itself and render reference to the "real nature of the transaction" 1942 U.S. Tax Ct. LEXIS 35">*43 meaningless.

In disposing of the somewhat related question of whether transfer of its stock to a corporation by one of its stockholders is a sale or a distribution in partial liquidation, the Board has laid emphasis upon the corporate purpose in acquiring the stock and its intention with respect to reissue. Thus, in , the Board, in concluding that the transaction in question was an exchange, pointed out that "The evidence discloses that they [the acquired shares] were placed in the treasury with the intention that they would be used to purchase additional properties * * *." And in , which reached a similar result, , was distinguished by pointing out that there "the evidence, thus, clearly established that the intention of the corporation was not to purchase its stock but to liquidate it."

We view these decisions as establishing the propositions, first, that whether a corporation's dealings in its own stock result in tax consequences to the corporation, depends upon the character1942 U.S. Tax Ct. LEXIS 35">*44 and purpose of the purchase and of the sale and their relationship to each other; second, that if their true nature is a readjustment of capital, no taxable gain or loss occurs even though the result is more than a mere bookkeeping process and the outcome may in a real sense be a benefit or detriment to the corporation's economic position; and, third, that one test of the true nature of the transaction is whether the corporation has dealt in its stock in the same way that it would in the stock of another corporation. This proceeds from a mere matter of construction and entirely without reference to any constitutional question of the power to tax such transactions in a different context of statutory interpretation. See ; .

The present record leaves no doubt that petitioner's original purchase of its stock had as its object an agreed readjustment of the corporation's capital structure. The interested parties had arrived at a decision calling for equal division in the control of the company. One of the participants was financially unable to pay1942 U.S. Tax Ct. LEXIS 35">*45 for his allotted half of the then outstanding shares. The result was the agreement to have the corporation purchase the difference, thus maintaining the balance among the stockholders. There is no suggestion of any other purpose and no inference that it was significant whether the stock was 1 T.C. 80">*85 retained in the corporation's treasury or definitively retired. The same result could have been reached by a simultaneous reduction in the authorized capital of the corporation; but the failure to adopt that procedure in no way interfered with the accomplishment of the immediate end or indicates to us that there was any other.

Two years later the corporation found itself in need of funds in order to distribute a dividend made advisable by the undistributed surplus tax. A series of steps was thereupon undertaken, the ultimate effect of which was to sell to the corporation's existing stockholders an additional amount of stock. Again it seems to us clear that this was a purpose dictated by the necessity of making a readjustment of the corporation's capital. That the same stock which had previously been purchased and held in the treasury was used, is entirely without significance. If1942 U.S. Tax Ct. LEXIS 35">*46 the original shares had been canceled, and the authorized capital reduced, that process could have been reversed and new stock authorized and sold. The result at the beginning and end would have been the same.

Nor was this an operation which could as well have been accomplished by a dealing in the stock of another corporation. Clearly, the purchase of other corporate securities would not have crystallized the shareholders' interests. Equally, the sale of other corporate stock, while it might have raised the necessary cash, would not have increased the corporation's capital, nor left its gross assets undiminished, as the sale of its own stock actually did. We think this embodies a transaction the real nature of which denies the realization of taxable gain under the regulation.

The cases which have passed upon this question do not conflict with such a conclusion. In ; certiorari denied, , the corporation had purchased its stock on "50 percent margin." In , the stock in question1942 U.S. Tax Ct. LEXIS 35">*47 was received in an exchange and the conclusion reached was that the taxpayer there had obtained a gain on the exchange which was taxable; in other words, the profit on the property exchanged and not on the stock acquired was there involved, a situation expressly covered by the regulation. In , "the capital structure of petitioner was not affected. No capital transaction, in fact, occurred. It is admitted that the stock was purchased for resale and sold." , is to the same effect. And in , "the stock was purchased and was resold for the profit to be made. That such profit was intended to be used, and was used to retire a different grade of stock, seems to us not to detract from the commercial character of the purchase and sale of 1 T.C. 80">*86 the common stock. The profit might well have been made from purchase and sale of stock in some other corporation."

Here, on the other hand, the facts show that the profit secured by petitioner was a mere incident. The original purchase of1942 U.S. Tax Ct. LEXIS 35">*48 the stock was entirely without reference to any future disposition and in fact the record shows that the interested parties affirmatively contracted against any resale, which would indeed have nullified the purpose of the purchase. The acquisition in one year and the sale several years later were in no way related in plan or object and had no connection save that their subject matter was the same stock. Both the purchase and the sale were made for purposes of readjusting petitioner's capital and the desired result in neither case could have been accomplished by a dealing in the stock of some other corporation. Respondent's determination seems to us to have been an erroneous application of his own regulation.

Decision will be entered under Rule 50.