Evening star., 1939-07-10
Corporations Reduce
Taxes by Exchanging
Preferred Shares
Shifts to Bond Issues
Change Dividends
To Interest
BY the Associated Press.

NEW YORK, July 10-A num-
Der of prosperous corporations
throughout the country, loaded down
with taxation, have reduced the bur-
den materially by persuading their
| preferred stockholders to exchange
their shares for bonds.
| In other words, says Lionel J. Free
man, New York lawyer, writing in
Barron's Weekly, the former stock
holder receives interest rather than
dividends. Interest is an expense
which is deductible in computing
the corporations net income in Fed
eral and State income taxes. Divi-
dends are not.
Suppose" says Freeman, "a New
York corporation with $l0,000,000 OF
outstanding preferred stock normal
ly pays 100000 a year in dividends
to its preferred stockholders. If the
corporation similarly distributes the
balance of its earnings to its other
stockholders, 1t will only eliminate
the present 2l2 per cent undistrib-
uted profits tax, which, on such
100000 payment, would amount to
only S17500. Even this advantage
will be gone after December 81, for
the new revenue act rings the cur
tain on the undistributed profits tax
and imposes fiat 18 per cent rate.
Most of S168,000 Saved.
THE corporations 100000 of
earnings distributed to preferred
stockholders in 1910 will be then
taxable to it at a total of "a per
cent 08 per cent Federal tax plus
per cent New York;, or S168,OOO
But if the corporation had instru-
ments of indebtedness outstanding
instead of preferred stock, the same
100000 payment to security hold
ers would constitute interest. de-
ductible as such to reduce its tax
able net income, and all or most of
the S168,000 tax would be saved"
This tax-saving method, Freeman
asserts, has been upheld in a num-
ber of recent decisions by the
United States Court of Tax Appeals
and even by the Supreme Court. 1t
is known in corporation and tax
law as "recapitalization."
1t is Encouragement of a corpo-
rations financial structure by VOL
untary agreement between the
stockholders and creditors to change
and increase or decrease the corpo-
ratlonS stock or debts, or both. AS
applied to the tax saving it involves
the substitution of indebtedness
type securities for outstanding pre-
ferred stock"
Burden Is Reduced.
The stockholder, of course, loses
his equity in the corporation-that
is, his partnership in it and his
right to vote or participate in its
management. His status becomes
that of creditor only, entitled to a
fixed rate of interest, payable re-
gardless of earnings, and with the
right to enforce payment by suit.
This recapitalization DEVICE"
Freeman asserts, permits corpora
tions not only to reduce their tax
load substantially, but, in certain
instances, to strengthen their finan-
clal structures as we'll.
The reason for this is that the
name bond or 'debenture' generally
has certain glamour for the inves-
tor, and some corporations entering
a business upswing have, therefore,
found it possible to effect the plan
and, at the same time, persuade
their preferred stockholders to sur
render their shares and wholly re-
lease their claims for large sums of
unpaid accumulated dividends in ex-
change for very long term obliga-
,tions with a much lower interest
rate.
I'm such cases, if none of the obli-
cations issued are in payment of the
accumulated dividends which were
due on the stock, then the entire
exchange will be accomplished tax
free to the holders"