(a), (f), and (g), are set forth in the margin. The petitioner therefore argues (in addition to the above discussed contention as to nontaxable reorganization) that the facts negative each of respondent's views.

We dispose at once of the idea that there may have been cash dividend. No cash passed. We find no cash dividend.

Was there stock dividend? In our opinion there was not. No dividend was declared, and we have indicated the necessity of declaration as requisite to finding of stock dividend. J. Weingarten, Inc., 44 B. T. A. 798; Humphryes Manufacturing Co., 45 B. T. A. 114. Nor was there any capitalization of surplus. Surplus remained the same before and after the change in corporate structure. Webster's New International Dictionary defines "stock dividend" as:

Stock dividend. Finance. The distribution by a corporation to its shareholders of additional stock created by capitalizing its surplus or from the stock of subsidiary corporations. Also, the stock so distributed.

The case of Bass v. Commissioner, supra, at pages 304 and 305, contains the following discussion on this point:

"A stock dividend always involves a transfer of surplus (or profit) to capital stock." Graham and Katz, Accounting in Law Practice, 2d ed. 1938, § 80. As the court said in United States v. Siegel, 8 Cir., 1931, 52 F. 2d 63, 65, 78 A. L. R. 672 : "A stock dividend is a conversion of surplus or undivided profits into capital stock, which is distributed to stockholders in lieu of a cash dividend." Congress itself has defined the term "dividend" in § 115 (a) of the Act as meaning any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits. In Eisner v. Macomber, 1920, 252 U. S. 189, 40 S. Ct. 189, 64 L. Ed. 521, 9 A. L. R. 1570, both the prevailing and the dissenting opinions recognized that within the meaning of the revenue acts the essence of a stock dividend was the segregation out of surplus account of a definite portion of the corporate earnings or profits theretofore available for SEC. 22. GROSS INCOME.

(a) GENERAL DEFINITION.-"Gross income" includes gains, profits, and income derived from *; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever.

SEC. 115. DISTRIBUTIONS BY CORPORATIONS.

(a) DEFINITION OF DIVIDENDS.-The term "dividend" when used in this chapter

means any distribution made by a corporation to its shareholders, whether in money or in other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year • without regard to the

amount of the earnings and profits at the time the distribution was made.

(f) STOCK DIVIDENDS.

(1) GENERAL RULE.-A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall not be treated as a dividend to the extent that it does not constitute income to the shareholder within the meaning of the Sixteenth Amendment to the Constitution.

(g) REDEMPTION OF STOCK.-If a corporation cancels or redeems its stock (whether or not such stock was issued as a stock dividend) at such time and in such manner as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

dividends, the freezing of such segregated earnings as part of the permanent capital resources of the corporation by the device of capitalizing the same, and the issuance to the stockholders of additional shares of stock representing the profits so capitalized.

* **

This result is not changed by section 115 (b) of the Internal Revenue Code, which provides that "* every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits * * *" because that section neither "prescribes the criteria for determining when a distribution has taken place, as distinguished from an exchange which is governed by section 112," nor "converts what is not income into income." 5 We conclude that no stock dividends are here involved, and that section 22 (a), in so far as it relates to dividends, and section 115 (a) and (f) (1) of the Internal Revenue Code are not applicable.

(b) Respondent next contends in the alternative that the transactions in the instant cases fall within the purview of section 115 (g) of the Internal Revenue Code, i. e., that the distribution by United of 400 shares of preferred stock and the cancellation of the 400 shares of common stock took place at such time and in such manner as to make the distribution and cancellation essentially equivalent to the distribution of a taxable dividend. A similar argument was rejected in the case of H. Y. McCord, 31 B. T. A. 342, in which this Court stated at page 343: "No question arises under section 115 (g) because, as we have seen, the cancellation of outstanding shares was not for cash, but only in exchange for new common and preferred shares." Section-115 (g) provides that "the amount so distributed in redemption or cancellation of the stock, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend." As has already been stated, there was no distribution out of earnings and profits in the instant cases; the surplus and capital stock accounts both remained unchanged in amount. To come within the scope of section 115 (g), the distribution must result in a pro tanto reduction of the corporation's capital; in other words, section 115 (g) is limited to a distribution out of earnings and surplus. South Atlantic Steamship Line, 42 B. T. A. 705, 714. We conclude that section 115 (g) of the Internal Revenue Code is not applicable.

The gravamen of respondent's position in these cases is stated in his brief as follows: "What actually transpired in the instant case is that there was a partial liquidation of the common stock resulting in a paid-in surplus followed by either (1) a cash dividend, the profits of which were used to acquire preferred stock, /or (2) a taxable divi

Bass v. Commissioner, supra, at page 308.

Leland v. Commissioner, 50 Fed. (2d) 523, 525.

dend in preferred stock on common to the extent of the preferred stock issued." To agree with that theory would require the breaking up of a single transaction, which is an exchange, into a series of transactions. "Whether an apparently integrated transaction shall be broken up into several separate steps and whether what apparently are several steps shall be synthesized into one whole transaction is frequently a necessary determination in deciding tax consequences." Dobson v. Commissioner, 320 U. S. 489. See also, Helvering v. New Haven & S. L. R. Co., 121 Fed. (2d) 985, 988. It is the duty of this Court to make that determination from the evidence. The facts show that United did not declare a stock dividend in form and that the . petitioners never had any thought at the time of these transactions of effecting a partial liquidation of United. We, therefore, can find no basis in the evidence in these cases which justifies regarding the transactions here in question in any other light than that of an exchange. To support respondent's contention would require a finding of fact contrary to the evidence.

The respondent further contends upon brief that the petitioners realized a taxable gain upon the disposition by each of 150 shares of preferred stock for $15,000 in partial satisfaction of their respective indebtedness to the estate of Louis Wellhouse, Sr. The gain or loss from that transaction is not properly before this Court, as that issue was not raised by the pleadings. H. Elkan & Co., 2 T. C. 597, 606, 607; William H. Joseph, 43 B. T. A. 273; Warner G. Baird, 42 B. T. A. 970, 975; Citizens Nat. Trust & Sav. Bank of Los Angeles, 34 B. T. A. 140, 145. Even if the respondent were permitted to assert this issue at this time, he could not prevail because, looking at these transactions as a whole, it is obvious that there was no gain realized by the petitioners on the disposition of these shares of preferred stock. This is true whether we regard their basis as the cost of the common shares for which they were exchanged, to wit, $123.37, or the fair market value of each share of preferred stock, to wit, $100. The increase in the book value of the remaining shares of common stock is not taxable until some disposition is made thereof. Eisner v. Macomber, 252 U. S. 189; Malone v. Commissioner, 128 Fed. (2d) 967; Clark v. Commissioner, 77 Fed. (2d) 89.

Petitioners do not assign as error denial of any loss as a result of these transactions under section 112 (a) of the Internal Revenue Code, and respondent does not claim they realized a taxable gain under that section. It follows that the Commissioner's determination of deficiencies in the income tax liability of the petitioners was in error. Decisions will be entered under Rule 50.

(a) GENERAL RULE.-Upon the sale or exchange of property the entire amount of the gain or loss, determined under section 111, shall be recognized, except as hereinafter provided in this section.

GREEN BAY & WESTERN RAILROAD COMPANY AND THE AHNAPEE & WESTERN RAILWAY COMPANY, PETITIONERS, v. Commissioner of INTERNAL REVENUE, RESPONDENT.

Docket No. 111726. Promulgated February 28, 1944.

Green Bay & Western Railroad Co. had outstanding during the taxable years shares of common stock and certain class A and class B debentures. The debentures had no fixed date of maturity and provided for no fixed rate of annual return. They provided that the holders thereof should "in lieu of interest thereon, participate in the distribution of annual net income" in the manner set out in the debentures. Any disbursements in pursuance of such provisions had to be declared by the board of directors of the corporation in the same manner that dividends on the common stock were declared. It was provided that none of such payments should be cumulative. No remedy was provided for default in payments. Held, these debentures did not represent indebtedness of the corporation and the payments accrued thereon in the taxable years by the taxpayer were not deductible as interest under section 23 (b), Revenue Act of 1936 and the Internal Revenue Code.

Clarence Castimore, Esq., for the petitioners.

John D. Kiley, Esq., and Charles Munz, Esq., for the respondent.

The Commissioner has determined deficiencies in income tax against petitioner Green Bay & Western Railroad Co. and its affiliated corporation, the Ahnapee & Western Railway Co., of $30,143.03 for 1937 and $4,196.43 for 1939, a total of $34,339.46.

The deficiencies are due to several adjustments made by the Commissioner in the income tax returns filed by Green Bay & Western Railroad Co. and its affiliated corporation, the Ahnapee & Western Railway Co., for the taxable years in question. None of these adjustments are contested except adjustment (a) made for each of the taxable years. That adjustment is explained in the deficiency notice as follows:

(a) The amounts paid to the holders of your so-called Class A Debentures and Class B Debentures, $220,000.00 for the year 1937, and $30,000.00 for the year 1939, have been disallowed as deductions from gross income. Said amounts, however, have been included in the computation of your dividends paid credits for the years 1937 and 1939 under Section 27 of the Revenue Act of 1936 and the Internal Revenue Code. It is held that the foregoing payments are not deductible from gross income as interest on indebtedness within the meaning of Section 23 (b) of the Revenue Act of 1936 and Section 23 (b) of the Internal Revenue Code; that the so-called debentures do not represent indebtedness within the meaning of that term as used in the statutes; and that they were intended to and do evidence a proprietary interest in your corporation.

By appropriate assignments of error petitioners contest this determination of the Commissioner.

FINDINGS OF FACT.

The petitioners are domestic corporations, with their principal office and place of business at Green Bay, Wisconsin. They filed their consolidated income tax returns for the calendar years 1937 and 1939 with the collector of internal revenue at Milwaukee, Wisconsin. Green Bay & Western Railroad Co., sometimes hereinafter referred to as petitioner, is a corporation organized and existing under the laws of the State of Wisconsin. The corporation was organized in the year 1896. The articles of incorporation provide that the amount of the capital stock of the corporation is $2,500,000, which consists of 25,000 shares of the par value of $100 each. All of the 25,000 shares were issued and outstanding in the years 1937 and 1939. The articles of incorporation provide that the rights, powers, privileges and franchises, and property of the predecessor corporations (the Green Bay, Winona & St. Paul Railroad Co. and the Green Bay, Stevens Point and Northern Railroad Co.) purchased under a decree of foreclosure of the railroads should be put into the new organization (the petitioner) for the following price:

Two million five hundred thousand dollars of capital stock divided into twenty-five thousand shares of One hundred dollars each, as above specified. Six hundred thousand dollars face value of instruments to be issued by said new company to be known as Class A Debentures, which debentures shall be issued in amounts of One Thousand Dollars each, and shall be payable only as follows, viz: in the event of any sale or reorganization of the railroad and property of said company, the net proceeds thereof, after payment of all liens and charges thereon, shall be distributed to and among the holders of said Class A Debentures, and the capital stock pro rata, and until such payment the holders of such Debentures shall be entitled in lieu of interest thereon to receive out of the net earnings of the railroad in each year applicable to the payment of dividends on the stock 22% upon the face value of such debentures if earned, and after payment of two and one-half per cent. (22%) dividend upon the said capital stock, to participate pro rata with the stock in the net earnings of the property for such year until five percent shall have been paid upon both the stock and the said Class A Debentures, the said debentures to contain such further provisions as may be agreed upon between the purchasers and the said company.

Seven Million Dollars face value of instruments to be issued by said new company to be known as Class B Debentures, which debentures shall be issued in amounts of One thousand Dollars each and shall be payable only in the event of a sale or reorganization of the railroad and property of said company and then only out of any net proceeds of such sale or reorganization which may remain after payment of all liens and charges upon said railroad or property, and after payment of Six Hundred Thousand Dollars to the holders of said Class A Debentures and Two Million five hundred thousand dollars to the stockholders, any such net proceeds remaining after such payments to be distributed pro rata to and among the holders of the said Class B Debentures, the holders thereof to be entitled to receive in lieu of interest thereon any net earnings of the railroad and property in each year remaining after payment of five per cent. upon the said Class B Debentures and the said stock. Such surplus net earnings, if any, to be paid to and distributed among the holders