opinion: PAULSEN et ux. v. COMMISSIONER OF INTERNAL REVENUE
  No. 83-832.
  Argued October 29, 1984
  Decided January 8, 1985
  Rehnquist, J., delivered the opinion of the Court, in which Brennan, White, Marshall, Blackmun, and Stevens, JJ., joined. O’Connor, J., filed a dissenting opinion, in which Burger, C. J., joined, post, p. 144. Powell, J., took no part in the decision of the case.
  William R. Nicholas argued the cause for petitioners. With him on the briefs was Karen S. Bryan.
  Albert G. Lauber, Jr., argued the cause for respondent. With him on the brief were Solicitor General Lee, Acting Assistant Attorney General Olsen, and Ernest J. Brown.
  Aaron M. Peck and Martin S. Schwartz filed a brief for the California League of Savings Institutions as amicus curiae urging reversal.
  Justice Rehnquist
  delivered the opinion of the Court.
  Commerce Savings and Loan Association of Tacoma, Wash., merged into Citizens Federal Savings and Loan Association of Seattle in July 1976. Petitioners Harold and Marie Paulsen sought to treat their exchange of stock in Commerce for an interest in Citizens as a tax-free reorganization under 26 U. S. C. §§ 354(a)(1) and 368(a)(1)(A). The Court of Appeals for the Ninth Circuit, disagreeing with the Court of Claims and other Courts of Appeals, reversed a decision of the Tax Court in favor of petitioners. 716 F. 2d 563 (1983). We granted certiorari, 465 U. S. 1021 (1984), to resolve these conflicting interpretations of an important provision of the Internal Revenue Code.
  At the time of the merger, petitioner Harold T. Paulsen was president and a director of Commerce. He and his wife, petitioner Marie B. Paulsen, held as community property 17,459 shares of “guaranty stock” in Commerce. In exchange for this stock petitioners received passbook savings accounts and time certificates of deposit in Citizens. Relying on 26 U. S. C. §§ 354(a)(1) and 368(a)(1)(A), they did not report the gain they realized on their 1976 federal income tax return because they considered the merger to be a tax-free reorganization.
  Before it ceased to exist, Commerce was a state-chartered savings and loan association incorporated and operated under Washington State law. It was authorized to issue “guaranty stock,” to offer various classes of savings accounts, and to make loans. Each stockholder, savings account holder, and borrower was a member of the association. Each share of stock and every $100, or fraction thereof, on deposit in a savings account carried with it one vote. Each borrower also had one vote.
  The “guaranty stock” had all of the characteristics normally associated with common stock issued by a corporation. Under the bylaws, a certain amount of guaranty stock was required to be maintained as the fixed and nonwithdrawable capital of Commerce. In accordance with Wash. Rev. Code Ann. §33.48.080 (Supp. 1981), holders of guaranty stock, but no other members, had a proportionate proprietary interest in its assets and net earnings, subordinate to the claims of creditors. Dividends could not be declared or paid on the guaranty stock unless certain reserves had been accumulated and dividends had been declared and paid on withdrawable savings accounts.
  Citizens is a federally chartered mutual savings and loan association under the jurisdiction of the Federal Home Loan Bank Board. 12 U. S. C. § 1461 et seq. It offers savings accounts and makes loans, but has no capital stock. Its members are its depositors and borrowers. Each savings account holder has one vote for each $100, or fraction thereof, of the withdrawal value of his savings account up to a maximum of 400 votes. Each borrower has one vote.
  Citizens is owned by its depositors. Twice each year its net earnings and any surplus are to be distributed to its savings account holders pro rata to the amounts on deposit. Its net assets would similarly be distributed if liquidation or dissolution should occur. It is obligated to pay written withdrawal requests within 30 days, and may redeem any of its accounts at any time by paying the holder the withdrawal value.
  The merger was effected pursuant to a “Plan of Merger,” under which Commerce’s stockholders exchanged all their stock for passbook savings accounts and certificates of deposit in Citizens. The plan was designed to conform to the requirements of Wash. Rev. Code §33.40.010 (1983), which provides for mergers between business entities, and to qualify as a tax-free reorganization under the terms of §§ 354(a)(1) and 368(a)(1)(A). Under the plan, Commerce stockholders received for each share a $12 deposit in a Citizens passbook savings account, subject only to the restriction that such deposits could not be withdrawn for one year. They also had the alternative of receiving time certificates of deposit in Citizens with maturities ranging from 1 to 10 years at the same $12-per-share exchange rate. The plan further provided that former Commerce stockholders could borrow against their deposits resulting from the exchange at 1.5% above the passbook rate as opposed to a 2% differential for other depositors. Following the exchange, the merged entity continued to operate under the Citizens name.
  Petitioners had a cost basis in their Commerce stock of $56,802; in the exchange they received passbook accounts and certificates of deposit worth $209,508. In 1976, 26 U. S. C. § 1002 (1970 ed.) required that “on the sale or exchange of property the entire amount of the gain or loss . . . shall be recognized.” Accordingly, petitioners were required to declare as income on their 1976 return the $152,706 profit unless one of the exceptions incorporated by reference in § 1002 applied.
  Included among the exceptions to § 1002 were the corporate reorganization provisions set out in §§354 to 368. As already noted, petitioners have attempted to rely on § 354(a)(1), which provides:
  “No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.”
  Section 368(a)(1)(A) defines a “reorganization” to include “a statutory merger or consolidation,” and §§ 7701(a)(3), 7701(a)(7), and 7701(a)(8) further define the terms “corporation” to include “associations,” “stock” to include “shares in an association,” and “shareholder” to include a “member in an association.” There is no dispute that at the time of the merger Commerce and Citizens qualified as associations, petitioners qualified as shareholders, Commerce’s guaranty stock and Citizens’ passbook accounts and certificates of deposit qualified as stock, and the merger qualified as a statutory merger within these provisions of the Code. Accordingly, under the literal terms of the Code the transaction would qualify as a tax-free “reorganization” exchange rather than a sale or exchange on which gain must be recognized and taxes paid.
  Satisfying the literal terms of the reorganization provisions, however, is not sufficient to qualify for nonrecognition of gain or loss. The purpose of these provisions is “‘to free from the imposition of an income tax purely “paper profits or losses” wherein there is no realization of gain or loss in the business sense but merely the recasting of the same interests in a different form.’” Southwest Natural Gas Co. v. Commissioner, 189 F. 2d 332, 334 (CA5), cert. denied, 342 U. S. 860 (1951) (quoting Commissioner v. Gilmore’s Estate, 130 F. 2d 791, 794 (CA3 1942)). See Treas. Reg. § 1.368-l(b), 26 CFR §1.368-l(b) (1984). In order to exclude sales structured to satisfy the literal terms of the reorganization provisions but not their purpose, this Court has construed the statute to also require that the taxpayer’s ownership interest in the prior organization must continue in a meaningful fashion in the reorganized enterprise. Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U. S. 462, 468-470 (1933). In that case we held that “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.” Id., at 470. We soon added the requirement that “this interest must be definite and material; it must represent a substantial part of the value of the thing transferred.” Helvering v. Minnesota Tea Co., 296 U. S. 378, 385 (1935). Compare LeTulle v. Scofield, 308 U. S. 415, 420-421 (1940) (no retained property interest where transferor received transferee’s bonds), with John A. Nelson Co. v. Helvering, 296 U. S. 374, 377 (1935) (continuity of interest satisfied where non voting preferred stock received). Known as the “continuity-of-interest” doctrine, this requirement has been codified in Treas. Regs. §§ 1.368 — 1(b), 1.368-2(a).
  The present case turns on whether petitioners’ exchange of their guaranty stock in Commerce for their passbook savings accounts and certificates of deposit in Citizens satisfies this continuity-of-interest requirement. More generally, we must decide whether a merger of a stock savings and loan association into a mutual savings and loan association qualifies as a tax-free reorganization. Following his ruling in Rev. Rul. 69-6, 1969-1 Cum. Bull. 104, which itself apparently was at odds with his earlier policy expressed in Rev. Rul. 54-624, 1954-2 Cum. Bull. 16, the Commissioner rejected petitioners’ treatment of the Commerce-Citizens merger as a tax-free reorganization under §§ 354(a)(1) and 368(a)(1)(A) and issued a statutory notice of deficiency finding petitioners liable for tax on their entire $152,706 gain.
  Petitioners sought redetermination of the deficiency in the Tax Court, which found that the Commissioner’s position had been uniformly rejected by the courts. Following Capital Savings and Loan Assn. v. United States, 221 Ct. Cl. 557, 607 F. 2d 970 (1979); West Side Federal Savings and Loan Assn. v. United States, 494 F. 2d 404 (CA6 1974); Everett v. United States, 448 F. 2d 357 (CA10 1971), the Tax Court reasoned that the savings accounts and certificates of deposit were the only forms of equity in Citizens, and it held that the requisite continuity of interest existed. 78 T. C. 291 (1982).
  The Commissioner appealed to the Court of Appeals for the Ninth Circuit, which declined to follow the cases cited by the Tax Court and reversed. 716 F. 2d 563 (1983). It reasoned that “despite certain formal equity characteristics” the passbook savings accounts and time certificates of deposit “are in reality indistinguishable from ordinary savings accounts and are essentially the equivalent of cash.” Id., at 569. For the reasons that follow we affirm the decision of the Court of Appeals.
  Citizens is organized pursuant to Charter K (Rev.), 12 CFR §544.1(b) (as of July 1, 1976), which provides for raising capital “by accepting payments on savings accounts representing share interests in the association.” These shares are the association’s only means of raising capital. Here they are divided into passbook accounts and certificates of deposit. In reality, these shares are hybrid instruments having both equity and debt characteristics. They combine in one instrument the separate characteristics of the guaranty stock and the savings accounts of stock associations like Commerce.
  The Citizens shares have several equity characteristics. The most important is the fact that they are the only ownership instrument of the association. Each share carries in addition to its deposit value a part ownership interest in the bricks and mortar, the goodwill, and all the other assets of Citizens. Another equity characteristic is the right to vote on matters for which the association’s management must obtain shareholder approval. The shareholders also receive dividends rather than interest on their accounts; the dividends are paid out of net earnings, and the shareholders have no legal right to have a dividend declared or to have a fixed return on their investment. The shareholders further have a right to a pro rata distribution of any remaining assets after a solvent dissolution.
  These equity characteristics, however, are not as substantial as they appear on the surface. Unlike a stock association where the ownership of the assets is concentrated in the stockholders, the ownership interests here are spread over all of the depositors. The equity interest of each shareholder in relation to the total value of the share, therefore, is that much smaller than in a stock association. The right to vote is also not very significant. A shareholder is limited to 400 votes; thus any funds deposited in excess of $40,000 do not confer any additional votes. The vote is also diluted each time a loan is made, as each borrower is entitled to one vote. In addition the Commissioner asserts, and petitioners do not contest, that in practice, when depositors open their accounts, they usually sign proxies giving management their votes.
  The fact that dividends rather than interest are paid is by no means controlling. Petitioners have not disputed the Commissioner’s assertion that in practice Citizens pays a fixed, preannounced rate on all accounts. As the Court of Appeals observed, Citizens would not be able to compete with stock savings and loan associations and commercial banks if it did not follow this practice. Potential depositors are motivated only by the rate of return on their accounts and the security of their deposits. In this latter respect, the Citizens accounts are insured by the Federal Savings and Loan Insurance Corporation (FSLIC), up to $40,000 in 1976 and now up to $100,000. 12 U. S. C. § 1728(a). The Code treats these dividends just like interest on bank accounts rather than like dividends on stock in a corporation. The dividends are deductible to Citizens, 26 U. S. C. §591, and they do not qualify for dividend exclusion by the Citizens shareholders under § 116.
  The right to participate in the net proceeds of a solvent liquidation is also not a significant part of the value of the shares. Referring to the possibility of a solvent liquidation of a mutual savings association, this Court observed: “It stretches the imagination very far to attribute any real value to such a remote contingency, and when coupled with the fact that it represents nothing which the depositor can readily transfer, any theoretical value reduces almost to the vanishing point.” Society for Savings v. Bowers, 349 U. S. 143, 150 (1955).
  In contrast, there are substantial debt characteristics to the Citizens shares that predominate. Petitioners’ passbook accounts and certificates of deposit are not subordinated to the claims of creditors, and their deposits are not considered permanent contributions to capital. Shareholders have a right on 30 days’ notice to withdraw their deposits, which right Citizens is obligated to respect. While petitioners were unable to withdraw their funds for one year following the merger, this restriction can be viewed as akin to a delayed payment rather than a material alteration in the nature of the instruments received as payment. In this case petitioners were immediately able to borrow against their deposits at a more favorable rate than Citizens’ depositors generally. As noted above, petitioners were also in effect guaranteed a fixed, preannounced rate of return on their deposits competitive with stock savings and loan associations and commercial banks.
  In our view, the debt characteristics of Citizens’ shares greatly outweigh the equity characteristics. The face value of petitioners’ passbook accounts and certificates of deposit was $210,000. Petitioners have stipulated that they had a right to withdraw the face amount of the deposits in cash, on demand after one year or at stated intervals thereafter. Their investment was virtually risk free and the dividends received were equivalent to prevailing interest rates for savings accounts in other types of savings institutions. The debt value of the shares was the same as the face value, $210,000; because no one would pay more than this for the shares, the incremental value attributable to the equity features was, practically, zero. Accordingly, we hold that petitioners’ passbook accounts and certificates of deposit were cash equivalents.
  Petitioners have failed to satisfy the continuity-of-interest requirement to qualify for a tax-free reorganization. In exchange for their guaranty stock in Commerce, they received essentially cash with an insubstantial equity interest. Under Minnesota Tea Co., their equity interest in Citizens would have to be “a substantial part of the value of the thing transferred.” 296 U. S., at 385. Assuming an arm’s-length transaction in which what petitioners gave up and what they received were of equivalent worth, their Commerce stock was worth $210,000 in withdrawable deposits and an unquan-tifiably small incremental equity interest. This retained equity interest in the reorganized enterprise, therefore, is not a “substantial” part of the value of the Commerce stock which was given up. We agree with the Commissioner that the equity interests attached to the Citizens shares are too insubstantial to satisfy Minnesota Tea, Co. The Citizens shares are not significantly different from the notes that this Court found to be the mere “equivalent of cash” in Pinellas & Cold Storage Ice Co., 287 U. S., at 468-469. The ownership interest of the Citizens shareholders is closer to that of the secured bondholders in LeTulle v. Scofield, 308 U. S., at 420-421, than to that of the preferred stockholders in John A. Nelson Co. v. Helvering, 296 U. S., at 377. The latter case involved a classic ownership instrument — preferred stock carrying voting rights only in the event of a dividend default — which we held to represent “a definite and substantial interest in the affairs of the purchasing corporation.” Ibid.
  Petitioners argue that the decision below erroneously turned on the relative change in the nature and extent of the equity interest, contrary to the holding in Minnesota Tea Co. that “the relationship of the taxpayer to the assets conveyed [could] substantially chang[e],” and only a “material part of the value of the transferred assets” need be retained as an equity interest. 296 U. S., at 386. In that case, taxpayers received voting trust certificates representing $540,000 of common stock and $425,000 cash; 56% of the value of the assets given up was retained as an equity interest in the transferee. In John A. Nelson Co., supra, the taxpayer received consideration consisting of 38% preferred stock and 62% cash. Here, in contrast, the retained equity interest had almost no value. It did not amount to a “material part” of the value of the Commerce stock formerly held by petitioners. See Southwest Natural Gas Co. v. Commissioner, 189 F. 2d, at 335 (insufficient continuity of interest where stock received represented less than 1% of the consideration).
  Petitioners’ real complaint seems to be our willingness to consider the equity and debt aspects of their shares separately. Clearly, if these interests were represented by separate pieces of paper — savings accounts on the one hand and equity instruments of some kind on the other — the value of the latter would be so small that we would not find a continuity of proprietary interest. In order not “to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose,” Gregory v. Helvering, 293 U. S. 465, 469-470 (1935), it is necessary in the present case to consider the debt and equity aspects of a single instrument separately. See Rev. Rul. 69-265, 1969-1 Cum. Bull. 109, 109-110, which treats the conversion rights incorporated in convertible preferred stock as “property other than voting stock” for purposes of § 368(a)(1)(C).
  Petitioners also complain that the result reached by the court below is inconsistent with the Commissioner’s position that a merger of one mutual savings and loan institution into another mutual association or into a stock association would still qualify as a tax-free reorganization. See Rev. Rul. 69-3, 1969-1 Cum. Bull. 103. If the continuity-of-interest test turns on the nature of the thing received, and not on the relative change in proprietary interest, argue petitioners, the interest received in the merger of two mutual associations is no different from the interest received in the instant case.
  As already indicated, shares in a mutual association have a predominant cash-equivalent component and an insubstantial equity component. When two mutual associations merge, the shares received are essentially identical to the shares given up. As long as the cash value of the shares on each side of the exchange is the same, the equity interest represented by the shares received — though small — is equivalent to the equity interest represented by the shares given up. Therefore, to the extent that a mutual association share reflects an equity interest, the continuity-of-interest requirement, as defined in Minnesota Tea Co., is satisfied in an exchange of this kind. The fact that identical cash deposits are also exchanged does not affect the equity aspect of the exchange. In the case of a merger of a mutual association into a stock association, the continuity-of-interest requirement is even more clearly satisfied because the equity position of the exchanging shareholders is not only equivalent before and after the exchange, but it is enhanced.
  Finally, petitioners argue that the characterization of their mutual association shares as debt conflicts with this Court’s decision in Tcherepnin v. Knight, 389 U. S. 332 (1967), holding that a withdrawable mutual association share indistinguishable from Citizens’ shares was a “security” within the meaning of §3(a)(10) of the Securities Exchange Act of 1934. Cf. Marine Bank v. Weaver, 455 U. S. 551, 557 (1982) (distinguishing Tcherepnin because the withdrawable capital shares there did not pay a fixed rate of return and “were much more like ordinary shares of stock and ‘the ordinary concept of a security’ . . . than a certificate of deposit” [in a bank]); Wisconsin Bankers Assn. v. Robertson, 111 U. S. App. D. C. 85, 294 F. 2d 714, 717 (Burger, J., concurring), cert. denied, 368 U. S. 938 (1961). The purpose of the Securities Acts is different from the purpose of the Tax Code. The focus in Tcherepnin was on the investment character of the shares, specifically whether they satisfied the test in SEC v. W. J. Howey Co., 328 U. S. 293, 301 (1946), for an investment contract, namely the “investment of money in a common enterprise with profits to come solely from the efforts of others.” Unlike the instant case, there is no requirement that the investors have a substantial proprietary interest in the enterprise. Moreover, in Howey as in this case, we disregarded the formal terms of the instruments in question and looked to their economic substance. Any remaining tension between the instant decision and Tcherepnin and Weaver can be explained by the fact that this Court has in cases such as Tcherepnin liberally construed the definition of “security” in the Securities Acts, while such liberality is not warranted in construing the scope of the reorganization provisions.
  The judgment of the Court of Appeals is
  Affirmed.
  Justice Powell took no part in the decision of the case.
  Capital Savings and Loan Assn. v. United States, 221 Ct. Cl. 557, 607 F. 2d 970 (1979); West Side Federal Savings and Loan Assn. v. United States, 494 F. 2d 404 (CA6 1974); Everett v. United States, 448 F. 2d 357 (CA10 1971).
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