Before BIGGS, MARIS and O'CONNELL, Circuit Judges.
O'CONNELL, Circuit Judge.
In this petition for review of a decision by the Tax Court, Hermoid Company seeks relief from a determination of certain income tax deficiencies for 1936 and 1937. Thermoid claimed a dividends paid credit in those years for dividends paid in shares of its common stock: Section 27, Revenue Act of 1936.*fn1 The Commissioner, ruling that the common stock was non-taxable to the stockholders under Section 112(b) (3),*fn2 disallowed the claim. The Tax Court sustained the Commissioner's holding.*fn3
As found by the Tax Court, these are the controlling facts: On September 30, 1936, Thermoid, a Delaware corporation, had a deficit of $1,410,811.50. As of this date, outstanding were 31,578 shares of seven per cent cumulative preferred stock of $100 par value. On these, there had accumulated unpaid dividends of $1,171,054.50, or about $38.50 per share. 296,096 shares of common stock, par value $1, were also outstanding.
To eliminate the deficit and "clear up" all arrears of dividends and sinking fund requirements on the preferred stock, a recapitalization was proposed and consummated. The ultimate result of the recapitalization was that the holder of each share of old preferred stock received 1 1/3 shares of new convertible preferred stock plus 4 shares of common stock. Arrears in dividends on the old preferred stock were eliminated without affecting Thermoid's cash or working capital. As stated in a letter of Thermoid's president to the stockholders*fn4 in which he commented on these changes, the refinancing of the corporation's maturing gold notes would thus be facilitated and a reorganization under Section 77B of the Bankruptcy Act, 11 U.S.C.A. § 207, be prevented.
It is clear, therefore, that this was a legitimate corporate reorganization with attendant tax consequences: cf. Bazley v. Commissioner, 3 Cir., 1946, 155 F.2d 237; The Okonite Company v. Commissioner, 3 Cir., 1946, 153 F.2d 248.
Thermoid's contention that the common stock issued to old preferred shareholders as a "dividend" was, for tax purposes, a taxable dividend to the shareholder and thus gave rise to a dividends paid credit requires analysis of the mechanics of the recapitalization. In August of 1936, Thermoid's board of directors passed appropriate resolutions and prepared a proposed amendment to the certificate of incorporation. Notice having been given, Thermoid's stockholders met on September 25, 1936, and approved the proposed amendment.
By its terms, the old preferred stock was required to be surrendered and "in lieu thereof" new preferred stock was to be issued (in a proportion of 1 1/3 new for 1 old share), thus eliminating all of the old preferred. The amendment then provided that holders of this new preferred, "shall be entitled in addition to the quarterly cash dividends * * * to a dividend of three shares of Common Stock for each share of * * * [new preferred] such dividend to be payable when and as declared by the Board of Directors. Such dividends in shares of Common Stock is in lieu of all dividends in arrears on the" old preferred stock. The amendment further provided that "In case the Corporation shall have failed to declare and pay on or before March 1, 1937, the dividend in shares of Common Stock * * * then so long as such dividend shall remain unpaid on the * * * [new preferred stock] the holders of the Common Stock shall have no voting power, and the holders of the * * * [new preferred stock] shall exclusively possess voting power for the election of directors and for all other purposes." This voting power of the new preferred shareholders was to cease upon the full payment of "said dividend in shares of Common Stock."
Here is the chronology of essential events:
September 30, 1936 - Reorganization consummated.
December 14, 1936 - Directors declared "special dividend" of one share of common stock on each share of new preferred stock.
December 28, 1936 - Thermoid issued 37,944 shares of its common stock as required by the "dividend" declaration and having a market value of $417,384.
January 21, 1937 - Directors declared a "special dividend" of two shares of common stock on each share of new preferred.
February 10, 1937 - Thermoid issued 81,112 shares of its common stock as required by the "dividend" declaration and ...