PARTNERSHIP REORGANIZATIONS

The rules outlined in connection with sales of single proprietorships apply with equal force to partnerships. In addition, the admission of a new partner and the adjustment of capital accounts at the time may offer new difficulties. The capital account of a new partner may be created by transferring portions of the existing capital accounts thereto, or by a cash or property payment directly to the partnership which is credited in toto to the account of the new partner; and where values established by new cash or property received by the partnership upon the admission of a new partner are not added to the capital accounts of the old partners, no taxable profit could possibly result.

Similarly, the creation of good-will or any addition thereto upon an adjustment of partners' interests does not give rise to taxable income merely because the capital accounts of the partners are increased, for the reason that the addition resulted from establishment of an intangible asset and not from a realized gain. But suppose that a newly admitted partner pays cash to the partnership which is credited, in whole or in part, to the capital accounts of the old partners, or pays cash directly to the individuals composing the partnership. In such cases the partners would be selling a portion of their interests for a consideration received by them, directly or indirectly, and a taxable gain or loss would follow, measured by the excess of the selling price over the cost or March 1, 1913, value of the interest plus the undistributed taxed profits. Pages 79-80 may be reviewed in this connection.

THE SUPREME COURT ON REORGANIZATIONS

The distinction between a stock dividend, a property dividend, and stock received in a reorganization may offer some difficulties. In the case of U. S. v. Phellis (257 U. S.,

156, T. D. 3270) a reorganization wherein all the assets of one corporation were transferred to another resulted in the taxation of the new securities received by stockholders on the basis of their fair value, the court holding that, as long as the old securities were retained, securities of the new corporation acquired by them were "assets of exchangeable and actual value severed from their capital interest in the old company, proceeding from it as the result of a division of former corporate profits, and drawn by them severally for their individual and separate use and benefit." The court also said: "It is the appropriate function of a dividend to convert a part of a surplus thus accumulated from property of the company into property of the individual stockholders; that the distribution reduces the intrinsic capital value of the shares by an equal amount is a normal and necessary effect of all dividend distributions whether paid in money or other divisible assets; hence, a comparison of aggregate values immediately before with those immediately after the dividend is not a proper test for determining whether individual income has been received by means of the dividend." It seems safe to conclude that under all acts prior to 1924 where a new corporation is formed from the "surplus assets" of another and the new stock is distributed to the old stockholders the market value of the new stock received is a property dividend and subject to tax. Even in 1926, the transfer of the stock of a subsidiary company purchased, say, in 1918, to the stockholders of the holding company is a taxable property dividend. It is important to remember that in 1926 such a transaction is free from tax only in case the exchange is made as the result of a reorganization (note again in this connection the provisions of Section 203 (c), (g), and (h)).

Again, a 1916 dividend in liquidation, consisting of the stock of a holding company which had purchased the stock of two subsidiaries formed from the corporation which declared the dividend, was regarded as (a) a segregated gain (b) from a corporation different in purpose from the origi

nal and organized in another state, (c) a corporation which might at any time sell the interests and realize the gain without affecting the holdings of the stockholders. The original corporation had a capitalization of $100,000 (the cost to stockholders) and the dividend in liquidation consisted of $3,000,000 in stock of the holding company and $1,500,000 in bonds from each of the two subsidiaries; the difference of $5,900,000 was held taxable (Cullinan v. Walker, 262 U. S., 134, April, 1923, T. D. 3508). By virtue of the reorganization provisions in the revenue acts since 1921 a transaction similar to the above would not be taxable.

In another 1916 reorganization in which the name of the company was slightly changed and the capital stock increased fivefold, the stockholders turned in all of their stock and received in exchange (a) $150 in cash on each share of old stock which had a par value of $100 and (b) new stock (par $250) representing one-half of their equity in the old corporation. The cash was obtained from the sale of the other one-half to outside interests. It was held that a closed transaction resulted from the sale of the one-half interest and that the balance of the exchange was not subject to tax (Weiss v. Stearn, 265 U. S., 242, May, 1924).

A new case has been added to the list of taxable reorganizations: Marr v. U. S. (268 U. S., 536, October, 1925; T. D. 3755). This was the reorganization of the General Motors Company in 1916, whereby (a) the securities issued in exchange were materially different from those surrendered, 6% non-voting preferred having been substituted for 7% voting preferred, (b) the relative proportion of preferred and common was changed, and (c) the New Jersey corporation became a Delaware corporation, having different rights, and the total capitalization increased from $30,000,000 to $102,600,000. The decision is in harmony with the general conclusions of U. S. v. Phellis and Cullinan v. Walker. The only distinction apparent between U. S. v. Phellis, Cullinan v. Walker, and Weiss v. Stearn lies in the char