OPINION.
Johnson, Judge:
The Commissioner determined a deficiency of $983.88 in petitioner's income tax for 1941 by adjustments not in controversy. In an amended petition petitioner asserts that he erroneously reported gains and losses from exchanges of bonds of the city of Philadelphia for refunding bonds of like amount issued by the city, and contends that the exchanges were nontaxable transactions because the old and new certificates represented the same property or because they were made in the course of a reorganization as defined in section 112, Internal Revenue Code. Other assignments of error were abandoned.
This proceeding was submitted upon a stipulation and exhibits, herein incorporated by reference as findings of fact. From these it appears that:
Petitioner, an individual residing at Oyster Bay, New York, filed his income tax return for 1941 with the collector of internal revenue for the second district of New York, at New York City. Prior to 1941 petitioner created a revocable trust, the income of which was con-cededly taxable to him. Among assets of this trust were seven lots of bonds issued by the city of Philadelphia, which bonds fell within the terms of a refunding plan submitted to the city by Drexel & Co. on April 10, 1941. By this plan, which was adopted and implemented by ordinances of June 9 and 12,1941, the city authorized the issuance of refunding bonds to be offered in exchange for designated issues of its outstanding bonds, bond for bond of equal principal amount. The refunding bonds, constituting a single consolidated issue, were to bear interest at the same rate as the outstanding bonds exchanged therefor until the first date on which the latter could be redeemed at the city's option and at a lesser rate thereafter. They were to bear coupons at issuance, but could be converted later into registered form if the holder desired. Drexel & Co. and Lehman Brothers were designated exclusive agents for the city in soliciting and making the exchanges, and for these services they were entitled to a commission of 1 per cent of the bond principal, payable by the applicant for exchange. The agents published and circulated a prospectus which invited exchanges and explained that outstanding bonds of $164,249,700 face value were eligible for exchange, while the face amount of refunding bonds authorized was limited to $131,064,000, and that applications for exchanges would Be considered in the order of their receipt by Drexel & Co.
The Girard Trust Co., as trustee of the trust created by petitioner, elected to exchange the bonds held by the trust for the authorized refunding bonds, and the seven lots, described below with date of acquisition and cost to the trust, were exchanged for refunding bonds as follows:
Bonds given In exchange
$12,000, 4% coupon, issued 12/30/19; due 7/26/72; callable 7/26/42; acquired 3/27/27; cost $13,080; surrendered 7/14/41.
$9,000, 4*4% coupon, issued 10/5/23; due 12/1/73; callable 12/1/43; acquired 3/27/27; cost $10,158.75; surrendered 7/14/41.
$35,000, 4% coupon, issued 9/22/24; due 1/1/75; callable 1/1/45; acquired 1925; cost $35,218.75; surrendered 12/1/41.
$11,000, 4*4% coupon, issued 12/30/19; due 2/1/74; callable 2/1/44; acquired 5/5/24; cost $11,082.50; surrendered 12/1/41.
$3,000, 4Yi% coupon, issued 10/5/23; due 9/16/75; callable 9/16/45; acquired 5/26/30; cost $3,033.75; surrendered 12/1/41.
$3,000, 4%% coupon, issued 12/30/19; due 12/1/75; callable 12/1/45; acquired 5/26/30; cost $3,033.75; surrendered 12/1/41.
Bonds received in exchange
$12,000, series B 1941, coupon 4% to 7/26/42; 2%% thereafter; due 1/1/49; callable 1/1/48; fair market value 7/14/41, $1,060,267 per M.
$9,000, series O 1941, coupon 4^4% to 12/1/43; 3% thereafter; due 1/1/68; callable 1/1/49; fair market value 7/14/41, $1,109,718 per M.
$35,000, series E 1941, coupon 4% to 1/1/45; 3%% thereafter; due 1/1/70; callable 1/1/51; fair market value 12/1/41, $1,116.70 per M.
$11,000, series D 1941, coupon 4%% to 2/1/44; 3%% thereafter; due 1/1/73; callable 1/1/48; fair market value 12/1/41, $1,103.10 per M.
$3,000, series G 1941, coupon 4%% to 9/16/45; 3%% thereafter; due 1/1/68; callable 1/1/54; fair market value 12/1/41, $1,141.10 per M.
$3,000, series I 1941, coupon 4%% to 12/1/45; 3%% thereafter; due 1/1/68; callable 1/1/54; fair market value 12/1/41, $1,152.80 per M. $62,000, 4%% coupon, issued 10/5/23; due 4/1/76; callable 4/1/46; acquired 4/19/28; cost $62,387.50; surrendered 12/1/41.
$62,000, series K 1941, coupon 4%% to 4/1/46; 3%% thereafter; due 1/1/66; callable 1/1/58; fair market value 12/1/41, $1,173 per M.
In surrendering the bonds the trustee sent a form letter of transmittal and paid the fee of $10 for each $1,000 bond exchanged. As agents for the city of Philadelphia, Drexel & Co. and Lehman Brothers were authorized to purchase outstanding bonds for cash, and made the following purchases:
The refunding bonds were general obligations of the city of Philadelphia, which was empowered to levy ad valorem taxes without limitation as to rate for their payment. The only material respects in which these bonds differed from the outstanding bonds are set forth in the above description. The outstanding bonds for which they were issued in exchange were canceled.
In his income tax return for 1941 petitioner reported long term capital gains and losses resulting from the trustee's exchange of outstanding bonds for refunding bonds. In this computation he reflected the fee of $10 per $1,000 bond paid to Drexel & Co. for making the exchange and the fair market value of the refunding bonds, which was shown by a valuation schedule of Drexel & Co. He paid income tax of $28,669.61, reported as due by his return, and on March 2,1945, filed a claim for refund, alleging error in reporting taxable gain on the exchange of the bonds.
Petitioner advances two arguments in support of his contention that no gain or loss should be recognized for tax purposes. The first is that the exchange falls within the ambit of City Bank Farmers Trust Co. v. Hoey (S. Dist. N. Y.), 52 Fed. Supp. 665; affirmed per curiam (C. C. A., 2d Cir.), 138 Fed. (2d) 1023; and Motor Products Corporation, 47 B. T. A. 983; affirmed per curiam (C. C. A., 6th Cir.), 142 Fed. (2d) 449. In both cases it was held that the taxpayer's exchange of bonds of the city of Detroit for refunding bonds of the same city resulted in no gain or loss recognizable for tax purposes because the bonds received were substantially identical with the bonds surrendered, and hence the taxpayer, acquiring merely a new evidence of the same indebtedness, made no exchange of property at all. For these decisions to be controlling, it is not enough that petitioner received refunding bonds substantially similar or of like kind to those surrendered; the degree of resemblance must be so great that the two certificates represent the same property rights, particularly since section 112 (b) (1), in providing that an exchange of investment property for property of a like kind is tax-free, expressly excludes exchanges of bonds.
So recognizing, petitioner urges, none the less, that the differences between the Philadelphia bonds surrendered and received are as immaterial as the differences ignored in the cited cases. We are unable to find that this is so. As stated in Motor Products Corporation, supra, the only difference in the old and new Detroit bonds was the maturity date, but:
such dates were of little or no significance to petitioner as a creditor of the city, for the city under the old defaulted bonds could have paid off any part or all thereof while they remained in default at any time funds were available and it likewise could have paid off any part or all of the new bonds, under its option .
The terms of the old and new bonds of Philadelphia, on the contrary, present several material differences: The interest rate of the refunding bonds, fixed to equal the rate of the old bonds until the latters' first call date, was substantially less thereafter; the refunding bonds matured earlier than the old bonds — in the case of series B, 23 years earlier; the refunding bonds' call dates, however, were later, and the refunding bonds could be registered, while the old bonds of all types were in coupon form.
Of material bearing on the issue, furthermore, is the city's inferable purpose in adopting the refunding plan and the method chosen to carry it into effect. The outstanding bonds bore a higher rate of interest than the current money market demanded; it would have been to the city's advantage to call the old bonds at the earliest call date, and to issue new bonds at lower rates. In effect it accomplished this result in an anticipatory manner by paying the old rate on the new bonds until the old bonds' first call date and the lower rate thereafter. The refunding bonds, so viewed, are thus clothed with the character of a new obligation, having different terms and conditions. Significantly, the exchange offered was optional with the bondholder; a fee of 1 per cent was charged for making it; the amount of refunding bonds authorized was less than the amount of old bonds eligible for exchange, and hence after complete execution of the plan bonds of prior issues remained outstanding. They constituted property distinct and different from the refunding bonds, and that difference was reflected, proved, and emphasized by disparities in market value. For these reasons we find that by the exchange the trustee acquired "a thing really different from what he theretofore had." Weiss v. Stearn, 265 U. S. 242, and hold that the resulting gains and losses are recognizable for tax purposes. Girard Trust Co. (Moore Estate) v. United States (E. Dist. Pa.), 69 Fed. Supp. 874; Thomas Watson, 8 T. C. 569; Walter H. Field, 41 B. T. A. 183.
As a second support for his contention, petitioner invokes section 112 (b) (3) of the Internal Revenue Code, providing that no gain or loss shall be recognized if stock or securities in a corporation are exchanged solely for stock or securities in such corporation pursuant to a plan of reorganization. By section 112 (g) the term "reorganization" is defined to include: "(E) a recapitalization ." And, since the city of Philadelphia is a municipal corporation, of which we take judicial notice, petitioner urges that by its refunding plan the city carried out a reorganization pursuant to which the trustee exchanged securities solely for securities in the same corporation, and hence no gain or loss is recognizable under section 112 (b) (3). He cites apt cases for the proposition that a reorganization may involve only an exchange of bonds for bonds, United Gas Improvement Co. v. Commissioner (C. C. A., 3d Cir.), 142 Fed. (2d) 216; Commissioner v. Neustadt's Trust (C. C. A., 2d Cir.), 131 Fed. (2d) 528, and argues that, since a municipal corporation is not expressly excluded by section 112, there is no reason to deny its bondholders the benefits of the section.
We are unable to agree. It seems manifest from the several provisions of section 112 that Congress referred to and only to the reorganization of a privately owned enterprise. The mergers, consolidations, stock, shareholders' control, and property transfers with which the section is concerned do not fit into the concept or activities of a municipal corporation, and only in exceptional transactions, such as an exchange of bonds for bonds, does the wording of the section so much as admit of meaning in respect of them. In holding taxable an exchange of assets for notes, the Supreme Court said in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462:
to be within the exemption the seller must acquire an interest in the affairs of the purchasing company more definite than that Incident to ownership of its short-term purchase-money notes. ♦ [Italics supplied.]
In the early leading case of Cortland Specialty Co. v. Commissioner (C. C. A., 2d Cir.), 60 Fed. (2d) 937, the court viewed the terms "reorganization," "merger," and "consolidation" as "indicating corporate readjustments of existing interests," and said of section 203, Revenue Act of 1926, predecessor of section 112:
Its purpose was to relieve those interested in corporations from profits taxes in cases where there was only a change in the corporate form in which business was conducted without an actual realization of any gain from an exchange of properties.
The section has as a "primary requisite that there must be some continuity of interest on the part of the transferor And to justify its application, securities given in exchange must create: "such obligations as to give creditors or others some assured participation in the properties of the transferee corporation.
In United Gas Improvement Co. v. Commissioner, 142 Fed. (2d) 216, the Circuit Court of Appeals for the Third Circuit gave as the underlying test for the section's application a "Continuity of ownership of a business enterprise following its reorganization
The Supreme Court, adopting these views, has been no less specific, saying in Le Tulle v. Schofield, 308 U. S. 415:
Where the consideration is wholly in the transferee's bonds, or part cash and part such bonds, we think it cannot be said that the transferor retains any proprietary interest in the enterprise.
And the court then held the section inapplicable because the taxpayer was not "one having a proprietary stake" in the issuing corporation. See also Helvering v. Alabama Asphaltic Limestone Co., 315 U. S. 179. As an individual can not acquire "a proprietary stake" in a municipal corporation, it follows that petitioner's exchange of bonds for bonds of the city of Philadelphia does not meet the underlying test.
The relation of section 112 to municipal corporations was considered in Speedway Water Co. v. United States, 100 Fed. (2d) 636, by the Circuit Court of Appeals for the Seventh Circuit, and from its opinion we quote the following remarks, with which we are fully in accord:
We find nothing in the statute to indicate that Congress intended that a municipal corporation should be included within "parties to a reorganization." Indeed, it seems apparent that the purpose of the exemption provisions included in the legislation was to remove an impediment to corporate readjustments and to prevent the taxation of purely fictitious gains. Mead Coal Co. v. Commissioner, 4 Cir., 72 F. 2d 22. A municipal corporation is not,engaged in business in the ordinary sense of the term and, though its activity in conducting a water plant may be denominated as exercise of a proprietary function rather than one governmental in character, such an activity is one permitted by the state legislature for the promotion and protection of the welfare of the citizens of the community, and partakes of none of the significant elements of an industrial, financial or other private business activity. Mergers, consolidations, reorganizations are, in the ordinary significance of those terms, confined to private corporations and the debates of Congress and the words of the statute disclose not the slightest evidence of intent that a sale of a water plant to a municipal corporation should be included in the exemption from taxes provided in case of reorganization of corporations.
Petitioner's exchanges of bonds for bonds constituted taxable transactions, on which gains and losses were properly reported and reflected in the computation of his income tax.
Reviewed by the Court.
Decision will ~be entered for the respondent.
Van Fossan, and Habron, JJ., concur only in the result.