to corporation Y, a party to a reorganization, under section 203 (b-3), for stock of Y Co. worth $200,000 and cash $50,000. The gain to corporation X of $50,000 is not taxable if corporation X distributes the $50,000 cash to its stockholders.

The Treasury intention in urging the insertion of the new section of the law, covering a situation on which no official ruling had ever been issued, is made clear in the following statement of Mr. Gregg:

A corporation in connection with a reorganization may dispose of its assets in one of three ways: It may transfer them to a new corporation in exchange for stock or cash; it may transfer them to the new corporation, the consideration being the payment by the new corporation of stock or cash to the stockholders of the old corporation; or the new corporation may buy, with its stock and cash, from the stockholders of the old corporation their stock, and then liquidate the old corporation. If a corporation adopts the first method, its gain from the sale could be taxed [under the 1921 law, but under the new section 203 (e) only if not distributed]. If it adopts the second method, the gain probably could be taxed on the theory of constructive receipt by the selling corporation. If it adopts the third method, there is no theory on which any gain to the old corporation could be taxed. As a result of these considerations, subdivision (e) has been so drafted that the tax liability on the selling corporation is the same no matter which of the three methods set out above is adopted. In other words, if the selling corporation is a mere conduit through which the consideration for the sale of the assets passes, or if the consideration for the sale of the assets is paid direct to the stockholders of the old corporation, without passing through the conduit, no gain or loss to the old corporation is recognized, and the same result is reached that would have been reached necessarily if the transaction were accomplished through the medium of a purchase by the new corporation of the stock of the old corporation, followed by a liquidation of the old.

NO LOSS RECOGNIZED.

LAW. Section 203.

(f) If an exchange would be within the provisions of paragraph (2) or (3) . . . . of subdivision (b) if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.

In neither of the cases discussed in the two preceding paragraphs (that is, exchanges of securities for securities plus "boot" and exchanges of property of corporations for securities plus "boot" in the course of reorganizations) is a loss from the exchange recognized. The reason for this rule is given on page 634.

Records must be kept.

REGULATION.

Records in substantial form, showing the basis

of the stock or property exchanged, and the amount of property or money received in exchange, must be kept to enable the determination of gain or loss from a subsequent disposition of the stock or property received or exchanged. (Art. 1574.)

Avoidance of double tax when corporate assets are sold for cash. The cases in which corporate assets are exchanged for reorganization securities or for such securities plus "boot" have been covered above.74 When a corporation sells its assets for an amount in excess of their book value (subject to adjustment for actual value at March 1, 1913), the corporation will be taxed on the excess. In turn, the stockholders, when distribution is made, will be taxed on the same amount (less the tax paid by the corporation). To avoid this double taxation the individual stockholders of the selling corporation should sell their stock to the vendee. When the purchaser acquires all the stock he or it may cause all of the assets of the corporation to be turned over for a nominal consideration. Thus the books of the corporation will not show any profit on the sale," or the old corporation can dissolve and distribute all of its assets to its stockholders who in turn convey to the purchaser, thus avoiding double tax.

75

Distribution of reorganization securities not considered a distribution of earnings.

LAW. Section 203. (g) The distribution, in pursuance of a plan of reorganization, by or on behalf of a corporation a party to the reorganization, of its stock or securities or stock or securities in a corporation a party to the reorganization, shall not be considered a distribution of earnings or profits within the meaning of subdivision (b) of section 201 for the purpose of determining the taxability of subsequent distributions by the corporation.

This section appears for the first time in the 1924 law. Its reason and its application are shown in the following example:

75

See pages 637 and 641.

76

[Former Procedure] The Treasury has sent to taxpayers in such cases an elaborate questionnaire to determine whether the old corporation sold its assets to the new corporation or whether the old stockholders sold or exchanged their stock. If the former, the Treasury usually assesses the old corporation in the face of an old Treasury regulation (Reg. 33, 1918, Art. 124) to the contrary. See Income Tax Procedure, 1922, page 555, and Income Tax Procedure, 1923, page 550. The Treasury holds that where a sale is made by one corporation of its capital assets to another, the fact that the consideration was paid to the old stockholders is immaterial. (C. B. II-2, page 202; A. R. R. 2954.)

76

From the Gregg memorandum of January 5, 1924.

Corporation A has a capital of $100,000 earnings and profits accumulated prior to March 1, 1913, of $25,000, and earnings and profits accumulated since March 1, 1913, of $50,000. It organizes corporation B to which it exchanges $50,000 of its assets in exchange for all the stock of corporation B. It then distributes the stock of corporation B as a dividend to its stockholders. Under the provisions of subdivision (c) of this section (see page 640), no gain from the receipt of this stock is recognized to the stockholders. Without a provision similar to this one, it could be argued that the distribution by corporation A constituted a distribution of earnings and profits, and under the presumption contained in section 201 (b), a distribution of the most recently accumulated earnings and profits of the corporation, with the result that it distributed all of the earnings and profits accumulated since March 1, 1913, and, consequently, that the corporation could not distribute tax-free the $25,000 of earnings and profits accumulated prior to March 1, 1913. The distribution by corporation A is not considered a distribution of earnings and profits for the purpose of determining the taxability of its stockholders upon the receipt of the stock of corporation B. and consequently should not be considered a distribution of earnings and profits accumulated since March 1, 1913, on hand for subsequent distribution as a dividend.

77

It should be noted that this subdivision covers the case in which A distributes, the stock of B as a dividend, the case in which A distributes the stock of B in retirement of a portion of its (A's) stock, and the case in which B issues its stock direct to A's stockholders.

Distribution of surplus of dissolved corporation.-Practically all reorganizations and consolidations result in the dissolution of pre-existing corporations. Taxpayers who receive cash or securities from a dissolving corporation should inquire as to whether or not the old corporation had an undistributed surplus account on its books. If so, such surplus as and when distributed to stockholders in dividends (or the equivalent of dividends) is free from all tax as to the part accumulated prior to March 1, 1913. Complete or partial liquidations, however, are treated as in full or part payment in exchange for the stock.78

Reorganization of limited partnerships of corporation type. The procedure in the case of dissolution of limited partnerships of the corporation type 79 is the same as that for corporations. If securities in a new corporation or limited partnership are received in exchange, it would be regarded as a distribution in kind and no

The text reads "not" in the printed copy of Gregg's report. Obviously it should read "now."

78 Section 201 (b); see Chapter XXXI as to diidends, and particularly the varying treatment of liquidating dividends under different laws.

See Chapter II.

tax would be imposed unless and until the securities were subsequently disposed of by the individual partners.80

80

See Chapter XXXIII. [Former Procedure]

The subject of exchanges and reorganizations under the 1918 law is treated at great length in Income Tax Procedure, 1921, in Chapters XIV and XV. Space does not permit the inclusion of old rulings and comments in this volume.

CHAPTER XXIV

INCOME FROM GAINS UPON SALE OR EXCHANGE OF PROPERTY-DETERMINING GAIN OR LOSS

BASIS AND COMPUTATION

1

Chapter XXIII discusses the conditions under which a sale or exchange is deemed to be a closed transaction, the results of which must be accounted for in a income tax return. This chapter deals primarily with the basis for determining gain or loss-the "basis" referred to in the following section:

The determination of March 1, 1913, value is treated in Chapter XXV while "capital gains and losses" are discussed in Chapter XXVI.