Petition for Review of Decisions of the United States Board of Tax Appeals.
Before SPARKS, Circuit Judge, and LINDLEY and BALTZELL, District Judges.
There is but one question presented by these petitions for review of decisions of the Board of Tax Appeals. It is whether any part of the profit from the sale, in the year 1930, of common stock of the Insull Utility Investments, Inc., acquired through the exercise of stock rights granted to the holders of the corporate preferred stock, first series, is taxable as capital gain, or whether all the profit is taxable as ordinary income. The Board of Tax Appeals held that it was taxable as ordinary income, and from that decision these appeals are prosecuted.
The petitioners, with Martin J. Insull, were the owners of substantial blocks of stocks of public utility companies operating in Chicago and its vicinity. They also owned a large amount of stock in Middle West Utilities Company, a public utility holding company. Except for a very small number, those shares had been held by petitioners for more than two years prior to December 27, 1928, and constituted capital assets. On that date, the Insull Utility Investments, Inc., was incorporated under the laws of Illinois, for the purpose of taking over and handling the stocks referred to. It had an authorized capital stock consisting of 250,000 shares of prior preferred, 250,000 shares of preferred, first series, and 3,000,0000 shares of common stock without par value. The petitioners and Martin J. Insull transferred their public utility stocks to the new corporation on January 4, 1929, receiving in exchange therefor, on January 11, 1929, all of the then issued preferred and common stock of the new corporation. They also received, on January 17, 1929, as further consideration for the securities so transferred, rights to purchase within a period of two years, at $15 a share, five additional shares of common stock for each share of preferred stock owned by them. At the time of their receipt, those rights had no value, but they became very valuable prior to the close of 1929. On December 31, 1929, Samuel Insull exercised a portion of his rights and thereby acquired 126,030 shares of the common stock, for which he paid $15 a share, and at the same time and for the same price a share, Margaret A. and Samuel Jr. exercised their rights, and acquired 29,640 and 18,460 shares, respectively.
On December 31, 1929, the common stock of the new company was trade in on the Chicago Stock Exchange at the following prices: High 58-3/4 per share, low, 57-1/2 per share, and closing, 58-3/4 per share, the sales on that day on the Chicago Exchange amounting to 8200 shares. On the same day, 900 shares were sold on the New York Curb Exhcnage at a high of 59-1/2, and a low of 56-1/8 per share.
On January 6, 1930, the petitioners sold a portion of the shares of the common stock thus acquired by them on December 31, 1929, in the following amounts and for the following prices: Samuel Insull, Jr., 11,415 shares for $449,100; Margaret A. Insull, 6,923 shares for $276,920; and Samuel Insull, 42,816 shares for $1,712,640.
In filing their income tax returns for 1930, petitioners reported the profits on those sales as capital net gains, while the Commissioner, in determining the deficiencies, treated them as ordinary gains or profits. The Board held that the stock obtained by the exercise of stock rights was not a capital asset within the meaning of section 101 of the Revenue Act of 1928 (26 U.S.C.A. § 101 note),*fn1 inasmuch as it had not been physically held for more than two years after the exercise of the rights.
It is contended by petitioners that their stock rights which they acquired on January 17, 1929, were capital assets, and that when in the exercise of those rights, they acquired additional stock in the investment company, the new shares thus acquired represented in part their old continuing interest in the assets of the corporation, and in part their new interest therein. We think these contentions must be admitted. The Board, however, held that the stock acquired by the exercise of the stock rights must have been held physically for two years after the exercise of the right before it could become a capital asset as defined by section 101 of the act. We think this position is erroneous. The old securities exchanged by petitioners constituted capital assets (except as to a negligible amount) at the time of the exchange, having been held by petitioners for more than two years. Sections of Revenue Act of 1928 above set forth, and also section 113 (a) (8), 26 U.S.C.A. § 113 note. In this ruling the Board relied upon its prior decisions in Rodman E. Griscom v. Commissioner, 22 B.T.A. 979, and Ellen Ayer Wood v. Commissioner, 29 B.T.A. 1050. The Griscom Case was not appealed, but the Wood Case was appealed and reversed by the Circuit Court of Appeals for the First Circuit, 75 F.2d 364, 366. Thereafter, on February 17, 1936, the Second Circuit reversed the Board on a similar holding. Macy v. Helvering (C.C.A.) 82 F.2d 183, 185.
In the Wood Case, the court said,
"* * * when new capital is added to the assets of an existing corporation each share represented by the certificates issued therefor is not a share in the new capital alone, but automatically spreads over and attaches itself to the whole and every part of the corporation and the old certificates liewise automatically come to represent interests in the new as well as the old. Therefore, when the petitioner purchased the 82 shares of stock in December, 1927, thus adding to her holdings of 1050 shares, she had 1132 shares each of which was a proportional interest in the whole corporation * * * and when she sold a share, whether by delivering an old or new certificate, she transferred a proportional interest in the whole corporation. A part of this interest * * * she had held for more than two years and a part she had acquired within the two years.
"That there is no distinction in the value and character of the new and old shares is stated by the Supreme Court in Miles v. Safe Deposit & Trust Co. [259 U.S. 247, 42 S. Ct. 483, 66 L. Ed. 923]."
In the Macy Case, the court said,
"The circumstance that the right to receive additional stock is conditioned upon the stockholder's contributing new capital to the corporation does not alter the fact that, when the condition is fulfilled, he receives what is essentially a partial stock dividend. The condition precedent does not destroy the identity of that portion ...