21 T.C. 600">*600 Respondent has determined deficiencies in income tax against the petitioner for the fiscal years ended November 30, 1947 and 1948, in the respective amounts of $ 4,533.40 and $ 15,390.49. These deficiencies arise through the inclusion in petitioner's income in those years of amounts represented by the difference between the price paid by petitioner in the acquisition of its own bonds which it retired in those years and the face amount of such bonds.

21 T.C. 600">*601 The proceeding was submitted upon a stipulation of facts, together with certain exhibits and the testimony of one witness.

FINDINGS OF FACT.

The stipulated facts are included herein by reference and so much as is necessary to an understanding of the issue1954 U.S. Tax Ct. LEXIS 307">*309 is hereinafter set out.

The petitioner is a New York corporation with office and principal place of business in Rochester, New York. Its returns for the taxable years here in question were filed with the collector for the twenty-eighth district of New York.

During its taxable years 1947, 1948, and 1949, petitioner had outstanding in the hands of the general public an issue of refunding 5 per cent registered debentures of the face value of $ 50 each, which came into existence in the manner hereinafter described.

During its taxable years 1947 and 1948, respectively, the petitioner owned all of the preferred and common stock of Weber & Heilbroner, Inc., and all of the preferred and 60 per cent of the common stock of Greenfield's Company, each of which affiliated companies during each of such years held some of the debentures, having acquired the same in the open market by purchase.

During its taxable year ended November 30, 1947, petitioner purchased from its said affiliates 3,093 debentures having an aggregate face value of $ 154,650 for the total sum of $ 147,087.05, and during its taxable year ended November 30, 1948, it purchased from its said affiliates 2,793 debentures having 1954 U.S. Tax Ct. LEXIS 307">*310 an aggregate face value of $ 139,650 for the total sum of $ 131,458. The price paid by petitioner to its affiliates as aforesaid was the same price at which the affiliates had acquired said debentures in the open market.

During its taxable year ended November 30, 1949, petitioner received as a dividend in kind on the common stock of its affiliate Weber & Heilbroner, Inc., 1,040 of the debentures having an aggregate face value of $ 52,000, and as a dividend in kind on the preferred stock of its affiliate Greenfield's Company, 190 of the debentures having an aggregate face value of $ 9,500. The fair market value of said debentures on the date of receipt thereof by petitioner as a dividend was $ 37,697.08 or $ 14,302.92 less than their face value in the case of those received from Weber & Heilbroner, Inc., and $ 7,642.50 or $ 1,857.50 less than their face value in the case of those received from Greenfield's Company. Petitioner included in its taxable income for its fiscal year ended November 30, 1949, the fair market value of the debentures received by it as dividends in that year.

During its taxable year ended November 30, 1949, petitioner had a net loss of $ 410,161.55 without including1954 U.S. Tax Ct. LEXIS 307">*311 as a part of its taxable income the sum of $ 16,160.42, being the aggregate difference between 21 T.C. 600">*602 the face value of the debentures received by it as dividends from its affiliates as aforesaid and the fair market value of said debentures on the date of receipt.

Shortly after the acquisition of the aforesaid debentures in each of its taxable years ending November 30, 1947, 1948, and 1949, respectively, petitioner retired and canceled the same, with the effect that said debentures thereafter did not constitute an obligation of petitioner. Petitioner credited to surplus the difference between the face value of said debentures and the price paid therefor, using fair market value in the cases of the debentures received in 1949.

The aforesaid debentures came into existence as a result of a reorganization of a predecessor corporation under which all of the assets of such corporation were received by petitioner and all of its obligations assumed. Such predecessor corporation, The Allendale Corporation, had, at the time of the acquisition of its assets and business by petitioner, 32,957 shares of its preferred stock outstanding. This preferred stock had been sold at a price of $ 51954 U.S. Tax Ct. LEXIS 307">*312 per share, but carried cumulative dividends at $ 3.50 per share and a liquidation value of $ 50 per share, its stated value on Allendale's books being the $ 5 at which it was issued.

At the time of the organization of petitioner and its acquisition of the assets of Allendale, it had an authorized capital stock structure identical to that of Allendale, and its common and preferred stock were issued in such acquisition in the identical amounts, share for share, of such stock of Allendale and distributed in the reorganization to the stockholders of that corporation. As a result of this reorganization petitioner had outstanding 32,957 shares of preferred stock with the stated value of $ 5 per share and a liquidating value of $ 50 per share, carrying the same provisions as the stock formerly issued by Allendale and for which it had been substituted.

As of April 1, 1943, dividends on petitioner's 32,957 shares of outstanding preferred stock had not been paid since April 1, 1938, and aggregated $ 17.50 per share or a total of $ 576,747.50. Petitioner was not at that time in a position to make payment of such accumulated dividends in cash. It was, however, anxious to refinance this issue1954 U.S. Tax Ct. LEXIS 307">*313 of preferred stock with a security carrying a less burdensome dividend or rate of interest to be paid from earnings. After discussion of the matter it was decided to offer to the holders of its preferred stock to exchange in a nontaxable reorganization, under section 112 (g) (1) (E) of the Internal Revenue Code, their preferred stock for a newly created issue of 20-year 5 per cent registered debentures of a face value of $ 50 each, one of such debentures plus $ 10 in cash to be exchanged for each share of outstanding preferred stock.

In preparation for the issue of these debentures and the carrying out of the plan decided upon, petitioner transferred from an account 21 T.C. 600">*603 on its books entitled "Capital Surplus" to its "Capital Account" $ 1,483,065, thereby increasing from a stated value of $ 5 a share to $ 50 a share the outstanding preferred stock which it intended to acquire. The aforesaid account denoted Capital Surplus entered upon petitioner's books represented unrealized appreciation in value of plant and facilities determined as a result of an engineering appraisal of value made by a firm of industrial engineers.

The foregoing offer to stockholders of one debenture plus1954 U.S. Tax Ct. LEXIS 307">*314 $ 10 in cash for each share of stock was accepted by some of the stockholders and the exchange effected on such basis. Later, petitioner acquired the balance of the outstanding preferred stock by the exchange of one debenture for each share plus an amount of cash in excess of $ 10 per share. The cash necessary in effecting the exchange of debentures for stock was borrowed by petitioner from banks.

In determining the deficiencies here in question, respondent increased petitioner's income for the 2 taxable years involved by the difference between the amounts paid by petitioner for such bonds, as hereinbefore detailed, and the face amount of such bonds, and by increasing petitioner's income for 1949 by the difference between the amount included by petitioner in income for that year as a result of its acquisition of bonds by way of dividends from its affiliates, petitioner having computed such gain upon the basis of fair market value at date of acquisition, and face value of the bonds. This increase in income resulted in a reduction of petitioner's net loss for 1949 subject to carry-back to the taxable years here involved.

OPINION.

It is petitioner's contention that cancellation of1954 U.S. Tax Ct. LEXIS 307">*315 the 5 per cent $ 50 debentures which it acquired in the taxable years resulted in no taxable gain, as the price paid upon the acquisition was in each case in excess of the $ 5 per share paid in for the preferred stock for which they were exchanged. With respect to the debentures received as dividends from its affiliates, petitioner contends that these represented income only to the extent of their fair market value at the date of such receipt, which amount is included in its income in the year of receipt.

Respondent does not dispute petitioner's contention that its debenture bonds were substituted for preferred stock, which in turn had been at a prior date substituted for the preferred stock of a predecessor corporation which had issued it at a price of $ 5, and that such transactions were in the course of nontaxable reorganizations and the debentures in consequence were to be considered as having been issued by the petitioner at a price of $ 5 each instead of the $ 50 stated value as carried on its books. Respondent argues that, irrespective 21 T.C. 600">*604 of circumstances of issuance of the debentures and what consideration may be considered as received therefor, from their issuance1954 U.S. Tax Ct. LEXIS 307">*316 they constituted a liability of the petitioner in their face amount and when acquired by petitioner for a lesser amount, the transaction resulted in a reduction of liabilities which constituted taxable income in that amount.

The respondent relies upon United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1, and Helvering v. American Chicle Co., 291 U.S. 426">291 U.S. 426, as authority for this contention. He argues that, no matter what the circumstances in connection with the assumption of liability, such liability is a claim against all corporate assets; that the release thereof for a sum less than its face amount constitutes a freeing of corporate assets to that extent; and that under these two decisions the difference between the amount paid in satisfaction of the obligation and the face of the obligation constitutes taxable gain.

From a careful study of 284 U.S. 1">United States v. Kirby Lumber Co., supra, we cannot agree that it supports respondent's contention. To construe that decision as respondent argues is, we think, to extend its rule far beyond the scope in which it is operative. In that case the corporate1954 U.S. Tax Ct. LEXIS 307">*317 bonds involved had been issued at par and were retired at a figure below the price received. There the issuing corporation after the retirement stood possessed of so much of the consideration which it had received upon issuance as exceeded the price it paid to purchase and retire the bonds. On these facts that decision was rendered. Any such difference between the issued and face price paid for their cancellation was held to have been realized as an addition to surplus and consequently was taxable gain. In that case there was in fact an actual gain to the corporation by the transaction.

The decision in 291 U.S. 426">Helvering v. American Chicle Co., supra, justifies no extension of the principle laid down in 284 U.S. 1">United States v. Kirby Lumber Co., supra. In that case the corporation had assumed certain liabilities in acquisition of assets and later compromised its indebtedness for a lesser amount. The Court there called attention to the deficiency in the record in its failure to advise the Court as to the value of the assets originally acquired. Without information as to such value no determination could be made that1954 U.S. Tax Ct. LEXIS 307">*318 a gain had not been realized, and there was a possibility that if such showing had been made it would have demonstrated a large gain as actually realized. Upon such facts the Court had no recourse but to apply the Kirby Lumber Co. rule, and sustained the Commissioner upon his determination of a gain representing the difference between the amount of the liability compromised and the sum paid in that settlement.

In the case at bar the petitioner has secured the settlement and discharge of its bond liability at a figure below its face amount. If by 21 T.C. 600">*605 reason of this transaction it stands now possessed of something in excess of what it had before, as was the case in Kirby Lumber Co., there would be no question of the application of the rule in that case. Here, however, the amount received originally as the basis of the obligation must be considered as $ 5 for each bond, and although the bonds represented a corporate obligation in their face amount, the retirement of that obligation for a lesser amount by a payment far in excess of the amount received upon the assumption of the liability does not in fact leave the petitioner with an increase in assets over what it had1954 U.S. Tax Ct. LEXIS 307">*319 before.

The question here presented was before us, upon what we consider as practically the same facts, in Rail Joint Co., 22 B. T. A. 1277. In that case, as here, the taxpayer, upon the basis of an engineering appraisal, determined a sum as representing appreciation in value of its assets, entering this upon its books as capital surplus. Against this sum so determined and entered, it issued bonds which it distributed to its stockholders as a dividend. Subsequently it purchased in the open market certain of these bonds at a figure far below their face price. On these facts, we said:

In our opinion, there has been no gain to be included in income from this transaction. We reach this conclusion not merely because the case is somewhat like numerous others already decided, but because an analysis of its own facts discloses less ground for a determination of income than some of those heretofore considered. National Sugar Mfg. Co., 7 B. T. A. 577; John F. Campbell Co., 15 B. T. A. 458 (now on review); Kirby Lumber Co., 19 B. T. A. 1046 (now on review); Coastwise Transportation Co., 22 B. T. A. 373.1954 U.S. Tax Ct. LEXIS 307">*320

* * * *

It is not enough to speak only of buying and retiring bonds for less than par; the question is whether there has been gain under all the circumstances, and this requires consideration of all that has been received or accrued on the one hand and given up on the other. * * *

At the time of our decision in Rail Joint Co., supra,284 U.S. 1">United States v. Kirby Lumber Co., supra, was pending for review by the Supreme Court. Our decision in Rail Joint Co. was reviewed by the Second Circuit and affirmed, 61 F.2d 751, in an elaborate opinion which cited, analyzed, and distinguished the opinion of the Supreme Court which in the meantime had been announced in 284 U.S. 1">United States v. Kirby Lumber Co., supra.

Since our decision in Rail Joint Co. there have been many decisions upon cases involving the retirement of corporate obligations at less than their face amount, and we have been unable to find in the opinion in any case a criticism of that decision or a different result reached upon facts similar to those there involved.

We can see no conflict between the decision1954 U.S. Tax Ct. LEXIS 307">*321 in the Rail Joint Co. case and Kirby Lumber Co. or American Chicle Co. In Kramon Development 21 T.C. 600">*606 ., 3 T.C. 342, we drew attention to the limitation of the Kirby Lumber Co. case, saying:

The discrepancy between the value of the property as we have found it and the face value of the bonds raises the question whether the latter were issued at par within the meaning of respondent's regulations. See Sacramento Medico Dental Building Co., 47 B. T. A. 315; cf. American Smelting & Refining Co. v. United States (C. C. A., 3d Cir.), 130 Fed. (2d) 883. But, if not, the Kirby case offers no guidance. Its reliance on the regulations, e. g., Regulations 62, art. 545, see Regulations 101, art. 22 (a) (18), demonstrates the area in which its operation was intended to be confined, and indicates that the difference between purchase price and face value is significant only where there is no discount upon issuance. See Terminal Investment Co., 2 T.C. 1004, 1013. We have consistently taken this view and emphasized the issue price rather than 1954 U.S. Tax Ct. LEXIS 307">*322 par value in computing gain from the discharge of obligations. * * *

In Kramon Development Co., supra, we held no gain to have been realized by the taxpayer as it was insolvent before and after the transaction.

Respondent contends that the Rail Joint Co. case is not only in conflict with Kirby Lumber Co. and American Chicle Co., but that this Court has repudiated that decision in Spear Box Co., 13 T.C. 238, affd. 182 F.2d 844. An examination of our opinion in that case discloses that the decision in Rail Joint Co. was not even mentioned, for the very evident reason that an entirely different situation was there presented. There was no suggestion in that case that the bonds of the taxpayer acquired by it at less than face value and retired had been issued at anything less than their full face value. Spear Box Co., supra, has no application here. It is a case falling squarely within the rule of Kirby Lumber Co.

This question of whether gain has been realized upon retirement of corporate obligations for less than face value has arisen under1954 U.S. Tax Ct. LEXIS 307">*323 various different and sometimes perplexing facts, but the decision in each type of case is predicated upon a determination as to whether there has been in fact an increase in the taxpayer's assets by reason of the transaction. If it has received more than it has paid out in cancellation of the indebtedness, the result is an increase in its surplus (284 U.S. 1">Kirby Lumber Co., supra); if it was insolvent before the transaction and was not made solvent thereby, it has no surplus increase and consequently there is no gain ( Kramon Development Co., supra;Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 70 F.2d 95; Lakeland Grocery Co., 36 B. T. A. 289; Texas Gas Distributing Co., 3 T.C. 57); if it has received upon issuance of its bonds an amount less than it paid for their retirement it has no accession in assets but is in fact poorer by the transaction ( Rail Joint Co., supra). A recognition of this basic principle is found in the decision by the Supreme Court in Bowers v. Kerbaugh-Empire Co., 271 U.S. 170">271 U.S. 170,1954 U.S. Tax Ct. LEXIS 307">*324 where it was held that, as the 21 T.C. 600">*607 result of the transaction left the taxpayer with a loss, no gain could be computed although one of the steps in the transaction was represented by the reduction of liabilities for a lesser amount.

Respondent calls attention to the fact that whenever a corporate liability is settled for less than its full amount there results an increase in book net worth. Under his theory an increase in book net worth has, for tax purposes, the same effect as an increase in earned surplus. With this we do not agree. A gift of assets to a corporation, such as one often made by a municipality to induce the location there of a plant, increases corporate net worth, but such increase is nontaxable income. Cf. Detroit Edison Co. v. Commissioner, 319 U.S. 98">319 U.S. 98. Also the determination of an unrealized increment in value of corporate assets upon the basis of an appraisal, which increase, as was the case here, set up on the corporate books as capital surplus, is reflected as an increase in book net worth. Respondent's theory would be to tax such increase as income, but to do so would be to disregard the test of income as laid1954 U.S. Tax Ct. LEXIS 307">*325 down in Eisner v. Macomber, 252 U.S. 189">252 U.S. 189, and the specific decision upon this question in LaBelle Iron Works v. United States, 256 U.S. 377">256 U.S. 377, which has been followed in an unbroken line of decisions, for it would tax as income the $ 45 of unrealized appreciation basing the issue of each $ 50 bond.

Upon the facts here disclosed, we hold that the petitioner realized no income in the retirement of the debenture bonds in question. ¹

Decision will be entered for the petitioner.