Appeal from United States Board of Tax Appeals.
Before MARIS and GOODRICH, Circuit Judges, and GANEY, District Judge.
The taxpayer was at one time the owner of four blocks of stock of a corporation known as Standard Sanitary Manufacturing Company, hereafter called Standard. She acquired them on four different occasions.
The first came to her under the intestate laws of Pennsylvania from the estate of her husband in 1909 as to which value is fixed, of course, as of March 1, 1913. The second came under the intestate laws of Pennsylvania from the estate of her son who died in 1917. The thild and fourth acquisitions were through purchases in open market in 1924 and 1926 respectively. The cost basis of each block of this stock was different from that any other.
During the period of taxpayer's ownership of these Standard shares there were certain stock dividends, split-ups and exchanges none of which raised questions in this litigation. The total holding in 1929 were 27,900 shares of Standard; the total cost of acquisition, $117,951.01.
In 1929, upon a non-taxable reorganization, the taxpayer surrendered all her Standard shares and received in exchange therefor 30,423 shares of American Radiator & Standard Sanitary Corporation (hereafter called Radiator) common stock. This was a non-taxable exchange under the Revenue Act of 1928, 26 U.S.C.A. Int. Rev. Acts, page 351 et seq.*fn1
From 1931 to 1936 inclusive, the taxpayer sold some of her Radiator shares in the open market. In 1938 she sold 5,500 shares It is the cost basis of the latter shares which is the subject of this litigation. The Commissioner says it is to be computed by an equal allocation of the cost of all the Radiator shares.*fn2 Petitioner wants a basis allocated to the cost of her two market purchases of 1924 and 1926, plus so much of the cost of her 1917 inheritance from her son as may be required to fill out the number of Radiator shares sold in 1938. If average cost is to be used, she says, then the straght average cost sgould be adjusted in such manner as to take into account the earlier sales, as shown in the Commissioner's original notice of deficiency.*fn3
We shall first discuss bridfly the application of the average cost rule. When a shareholder buys, at different times and at different prices, share in the same corporation, his $80 shares in just as great an interest in the corporate enterprise as the one for which he pays $110. But if he sells each at $120 it is too clear to be talked about that his profit is $30 greater on the low cost purchase than the high cost acquisition. If he sells only part of his shares and can identify what he sold as the block purchased at any particular price, then he pays his tax upon the gain from that transaction. Many cases turn upon the sufficiency of such identificartion. For examples, see Curtis v. Helvering, 2 Cir., 1939, 101 F.2d 40; Fuller v. Commissioner of Internal Revenue, 1 Cir., 1936, 81 F.2d 176; Rule v. Commissioner of Internal Rcvenue, 10 Cir., 1942, 127 F.2d 979. If no identification is established, the first in-first out rule provides a working basis for the imposition of a tax upon the profits of a particular transaction and insures the shareholder that if he keeps on selling he will eventually have all of his capital allowed. Though it seems to be a favorite rule of the Commissioner there is little else to commend it. The taxpayer's preference would undoubtedly be for the most expensive purchase as the one to be used as the basis of calculating the tax on an individual sale. We think the average cost of all the shares is the fairest of the three.
At any rate the courts have refused to follow the Commissioner's first in-first out rule when the taxpayer had exchanged the various blocks of stock in one corporation for the shares of another in a tax free reorganization. In those instances the average cost rule finds such firm support both from the Tax Court and various Circuits that it will take a Supreme Court decision or an act of Congress to change it. Commissioner of Internal Revenue v. Von Gunten, 6 Cir., 1935, 76 F.2d 670; Helvering v. Stifel. 4 Cir., 1935, 75 F.2d 583; Commissioner of Intenal Revenue v. Oliver, 3 Cir., 1935, 78 F.2d 561; Commissioner of Internal Revenue v. Bolender, 7 Cir., 1936, 82 F.2d 591; Fleischmann v. Commissioner of Internal Revenue, 1939, 40 B.T.A. 672. That this result was established against the contentions of the Commissioner does not of course preclude him from using it in his favor in subsequent litigation, even though it gives the taxpayer a chance to make faces at the tax collecting authorities.
We think it is the only sound rule. The old sharse all have the same exchange value for the new ones no matter what they cost the taxpayer. He gets as much new stock for the share for which he paid $80 as he does for the share for which he paid $120. The old shares lose their identity when traded for the new, just as the money with which one buys a war bond loses its identity in the certificate, though to the purchaser some of it may have been a gift, some won on a horse race and the remainder earned by the sweat of his brow.The old shares are gone; the new shares in what is at least nominally a new company take their place. Each new share costs the taxpayer the quotient of the sum of the cost of the old shares divided by the number of new shares he receives.
If this is correct, the question of identification drops out of the operative facts in determining the value of shares received in a tax free reorganization. If it be thought to go too far, and identification of new shares received for specifirf old ones is legally relevant, it will not help the taxpayer here for there is no identification. It was not possible to match any partcular certificate evidencing the 5,500 shares of Radiator sold in 1938 with any certificate the taxpayer had held in Standard. The taxpater conedes this. The sale of the shares was arranged through her son, who was conversant with her affairs, and who was connected with the brokerage house which made the sale on the taxpayer's account.
There is a finding that "The petitioner wished to diversify her holdings, but to pay as little tax as possible. Her son told her leave that to her attorney." We do not know the source of the particular Standard shares which procuded the certificates for Radiator shares. 5,500 of the latter were sold in 1938; the taxpayer's lawyer drew up her tax return, naturally enough, in a way which would make the most favorable tax showing for his client. But in it all we see no evidence of identification but only the very human desire of every taxpayer not to incur nore tax liability than he must.
Finally, the taxpayer contends that the Commissioner's gailure to make adjustment for the cost already allocated, by applying the first in-first out rule, to the shares sold prior to 1938 results in a tax upon capital. The Commissioner's first answer to this is that the 1938 tax cannot be such because the taxpayer by that time had not exhausted her cost basis. That point seems to us will taken so for as this tax is cotcerned. The taxplyer points out that she gets no relief from the mitigation section, § 820(f) of the Revenue Act of 1938, 26 U.S.C.A. Int. Rev. Acts page 1161, for it does not permit adjustment for years prior to January 1, 1932, and taxpayer paid, as part of her income tax for 1931, the tax upon the profits from the sale of Radiator stock in the year.*fn4 Should she, in her lifetime, sell all her shares of Radiator a portion of her cost base upon which ithe previous tax had been assessed would not be allowed for, and therefore a portion of the tax collected would be on capital, not income.*fn5 This attack on the constitutionality of the Commissioner's assessment mmujst fail.It may be conceded that the cost basis used prior to 1938 was erroneous and when no allowance therefor is made in 1938 and later years, petitioner will in effect not recover, free of tax, her entire capital investment. However, the petitioner, then, as now, could have litibated the matter to arrive at a correct determination. For same of the years in question, she may still be able to do so. The fact that she has waited past the limitation period for a ...