Taxation – Federal Income Tax – Exchange of Debentures for Preferred Stock as Tax-Free Reorganization

Plaintiff held common and preferred stock of the Gulf States Paper Corporation. In 1942 plaintiff received new debentures in exchange for his preferred stock, pursuant to a plan for the recapitalization of the company whereby the entire 25,000 shares of previously outstanding preferred stock (including plaintiff’s 208 shares) were exchanged for new debentures of like value. In 1950 the Commissioner assessed an income tax deficiency against plaintiff, determining that the redemption and cancellation of the preferred stock represented a distribution essentially equivalent to the distribution of a dividend and taxable under section 115(g)(1) of the Internal Revenue Code. Plaintiff sued for refund of the amounts paid on the deficiency assessment and was awarded judgment by the district court. On appeal, held, affirmed. The corporation’s exchange of debentures for preferred stock accomplished a reshuffling of the capital stock structure which constituted a “recapitalization” and hence a tax-free “reorganization” within the meaning of section 112(b)(3) of the Internal Revenue Code. Davis v. Penfield, (5th Cir. 1953) 205 F. (2d) 798.