Opinion
Docket Nos. 87610-87612, 87667.
Filed October 17, 1962.
Distributions upon redemption of all corporate stock pursuant to a plan under which corporate operating assets were sold to newly incorporated company, 72 2/3 percent owned by old company shareholders, followed by liquidation of old company, the plan accomplishing elimination of some old company shareholders and ownership, in part, of continuing business by some new shareholders, held properly treated as capital transaction under section 331 (a) (2), I.R.C. 1954, and not to result in ordinary income.
Henry D. Costigan, Esq., Gordon M. Weber, Esq., and John B. Lowry, Esq., for the petitioners.
Donald G. Daiker, Esq., for the respondent.
Respondent has determined deficiencies in income tax in these consolidated cases as follows:
Docket No. Petitioner 1955 1956 87610 Gallagher .......................... $16,884.90 $2,214.10 87611 Bush ............................... 178,236.52 10,346.56 87612 Grant .............................. 13,174.61 207.43 87667 Cuffe .............................. 126,933.87 15,877.91The issues remaining for determination are (1) whether a series of distributions received in liquidation of a corporation should be treated as taxable dividends or distributions of earnings and profits incidental to a reorganization within the meaning of sections 354, 356, and 368 of the Internal Revenue Code of 1954 and, if either, (2) whether the amount taxed as ordinary income should be reduced by the capital contribution to the original corporation or the capital contributed to a new corporation formed to conduct the business of the original corporation.
FINDINGS OF FACT.
The stipulated facts are hereby found accordingly.
West Coast Terminals, Inc., a Delaware corporation with its principal business office in San Francisco, California (hereinafter called Delaware), was organized on May 13, 1946. Delaware was at all material times until its dissolution, hereinafter described, engaged in the general stevedoring and terminal business, which consisted of providing under contract the services (including labor and equipment) required to load, unload, and handle cargo carried on vessels, including both loading and unloading of vessels and both loading and unloading of freight cars, trucks, and other vehicles for the purpose of transferring cargo to or from vessels. The business was conducted principally at various points on San Francisco Bay, at the port of Stockton, at the port of Los Angeles, at Long Beach harbor, all in California, and at Portland, Oregon. The equipment used in the business was generally owned by Delaware. The labor required in the business was generally performed by longshoremen employed by Delaware who were members of the International Longshoremen's and Warehousemen's Union and whose terms of employment were subject to contracts between the union and Pacific Maritime Association on behalf of Delaware.
William J. Bush (hereinafter called Bush), one of the petitioners in Docket No. 87611, was president and a director and stockholder of Delaware, holding 391 shares of its stock at all material times until its dissolution. Bush was the chief executive officer of Delaware and devoted full time to its management, including the supervision of its stevedoring and terminal operations, the supervision of its financial affairs, and the supervision of relations with the ship operators who were its customers or potential customers.
Joseph C. Gallagher (hereinafter called Gallagher), one of the petitioners in Docket No. 87610, was vice president and general manager and a director and stockholder of Delaware, holding 58 shares of its stock, at all material times until its dissolution. Gallagher was the second highest executive officer of Delaware and devoted full time to participation in its management, including participation in the supervision of its stevedoring and terminal operations, the supervision of its financial affairs, and the supervision of relations with the ship operators who were its customers or potential customers.
George H. Grant (hereinafter called Grant), one of the petitioners in Docket No. 87612, was a director and stockholder of Delaware, holding 57 shares of its stock at all material times until its dissolution. Grant was a member of the board of directors having general control of the management of Delaware and, in addition, assisted in its relations with the ship operators who were its customers or potential customers.
Thomas E. Cuffe (hereinafter called Cuffe) died on December 22, 1959. His estate, represented by the Bank of California, National Association, executor, is one of the petitioners in Docket No. 87667. Cuffe was a director and stockholder of Delaware, holding 267 shares of its stock, at all material times until its dissolution. Cuffe was a member of the board of directors having general control of the management of Delaware and, in addition, assisted in its relations with the ship operators who were its customers or potential customers and was himself president of one of the ship operators who were customers of Delaware, namely, Pacific Far East Lines, Inc.
The income tax returns for all petitioners for the years 1955 to 1957, inclusive, were filed with the district director of internal revenue at San Francisco, California.
The nine shareholders of Delaware consisted of two groups, as shown by the following schedule: Percentage Shares Stockholders of stock of stock
Bush ............................ 30.24 391 Cuffe ........................... 20.65 267 Gallagher ....................... 4.49 58 Grant ........................... 4.41 57 Burkman ......................... 2.16 28 ------------------- Total ...................... 61.95 801 Sexton (an estate) .............. 20.65 267 Seid (an estate) ................ 5.80 75 Lyon (a widow) .................. 5.80 75 Seidenspinner (a widow) ......... 5.80 75 ------------------- Total ...................... 38.05 492 Grand total ................ 100.00 1,293 The first group consisted of active executives and directors, as follows: Bush, Cuffe, Gallagher, and Grant, who were all directors of Delaware and two of whom were officers, and D. R. Burkman (hereinafter called Burkman), who was district manager in direct charge of all operations of Delaware in southern California, including Los Angeles and Long Beach harbor. The second group consisted of the remaining shareholders of record: Sexton Corporation, estate of J. J. Seid, deceased, Christine P. Lyon, and Mary Seidenspinner (hereinafter referred to as the estates and widows), all of whom were (or, in the case of Sexton Corporation, represented) shareholders who had acquired their stock through the death of persons formerly active in Delaware. In the case of Sexton Corporation, the stock had been transferred to William T. Sexton, who had subsequently died without such transfer being recorded on the books of Delaware. The beneficial owner of this stock at all times herein relevant was the estate of W. T. Sexton, deceased. Their predecessors in ownership of the stock of Delaware had been active in its business in the following capacities: William T. Sexton had been a director of Delaware and was also president of Coastwise Line, one of the customers of Delaware; J. J. Seid had been traffic manager of Crown Zellerbach Paper Corporation and an executive of Coastwise Line, one of the customers of Delaware; I. F. Lyon, the husband of Christine P. Lyon, until his death had controlled the shipping of a substantial amount of cargo as traffic manager of California Packing Corporation; and E. A. Seidenspinner, the husband of Mary Seidenspinner, before his death had been traffic manager of El Dorado Oil Company. The estates and widows were inactive and of no assistance to Delaware, and several members of this group wished to liquidate their interest because of the low yield and speculative nature of the business.Article 40 of the by-laws of Delaware provided that each stockholder desiring to sell his shares —
must upon each occasion first offer for sale said shares to the other stockholders of record. The other stockholders of record shall be entitled to purchase said shares so offered on a pro rata basis dependent on the percentage of stock issued and outstanding and which is owned by the respective purchasing stockholders. The stock shall be sold to the stockholders who desire to acquire the same at a price equal to the prevailing book value of said stock as determined by the books of account of the corporation * * *
The minutes of a meeting of the board of directors of Delaware on May 31, 1955, state in part as follows:
The President stated that he and certain other of the shareholders of [Delaware], together with other persons, were planning to organize a California corporation for the purpose of offering to purchase the operating assets and goodwill of [Delaware]. The President then presented to the meeting a Plan of Complete Liquidation of [Delaware] involving the sale of the operating assets of [Delaware] as aforesaid, to be followed by the dissolution and liquidation of [Delaware]. * * *
A special meeting of the stockholders of Delaware was held on June 14, 1955. The minutes of this meeting state in part as follows:
the following shareholders were represented either in person or by proxies in favor of W. J. Bush, J. C. Gallagher and M. O. Kurtz, jointly and severally, all of whom were also present at the meeting:
Name Number of shares
W. J. Bush ........................ 391 In person J. C. Gallagher ................... 58 In person George H. Grant ................... 57 In person D. R. Burkman ..................... 28 In person T. E. Cuffe ....................... 267 By proxy Mrs. Christine P. Lyons ........... 75 By proxy Estate of John J. Seid ............ 75 By proxy Mrs. Mary Seidenspinner ........... 75 By proxy
There were also present at the meeting Henry D. Costigan and Gordon M. Weber, attorneys for * * * [Delaware]. The Chairman stated that neither the Sexton Corporation, the holder of record of 267 shares, nor the Estate of W. T. Sexton, now understood to be the owner of said 267 shares, was represented at the meeting; and that such 267 shares were the only outstanding shares not represented at the meeting. He further stated that a letter had been received on June 10 from the attorneys for the Estate of W. T. Sexton, requesting additional information regarding the meeting and the business proposed to be transacted, and that he and Mr. Henry D. Costigan, as attorney for * * * [Delaware], had met on the morning of June 14, 1955, with Messrs. George Herrington, Orville A. Rohlf and Christopher M. Jenks, attorneys for the Estate of W. T. Sexton and had furnished them with full information concerning the proposed plan of complete liquidation and sale of operating assets. He reported that said attorneys expressed their approval of the plan and of the proposed sale of assets * * *
* * * * * * *
On motion of Mr. George H. Grant, seconded by Mr. D. R. Burkman, the following resolutions were adopted by the affirmative vote of all shares represented at the meeting:
RESOLVED, that the Plan of Complete Liquidation of * * * [Delaware] submitted to this meeting and hereby ordered to be made a part of the records of this meeting, be and same is hereby adopted;
RESOLVED, that, when and if * * * [Delaware] shall receive an offer to purchase the operating assets of * * * [Delaware], including its goodwill and the assignment of its operating contracts, then the President or Vice-President and Secretary are authorized and empowered to sell such assets at any price which in their judgment is deemed advisable; provided, however, that such price shall not be less than the book value thereof as of May 31, 1955, or as of the time of sale, whichever is less;
* * * * * * *
The Chairman stated that the assets to be sold comprised equipment and prepaid insurance having April 30, 1955 book values of $86,760.26 and $10,754.71 respectively. Such book values would be subject to adjustment for depreciation, for purchases of equipment after April 30, and other appropriate items.
The plan of liquidation of Delaware provided in part as follows:
2. Immediately upon adoption of the Plan, the shareholders voting for its adoption shall adopt appropriate resolutions authorizing the appropriate officers of * * * [Delaware] to take all necessary steps to sell and transfer the operating assets of * * * [Delaware], including its goodwill, and to assign its operating contracts. The sales price of such assets shall be not less than the book value thereof as of May 31, 1955, or as of the time of sale, whichever is less. It is understood and contemplated that such assets may be sold to a corporation some of the shareholders of which are also shareholders and/or officers of * * * [Delaware] * * *
* * * * * * *
5. If and when the operating assets of * * * [Delaware] have been sold as contemplated by Section 1 hereof, the officers and directors in so far as possible shall reduce all other assets of * * * [Delaware] to cash and upon compliance with the applicable laws of the State of Delaware may from time to time make one or more pro rata distributions in cash to the shareholders of * * * [Delaware] * * *
6. On or before, but not later than, May 1, 1956, all known assets of * * * [Delaware], except such assets as may be retained to meet claims against * * * [Delaware] which it shall not have been possible to discharge prior to that date, shall be distributed pro rata to the shareholders of * * * [Delaware] in complete liquidation of * * * [Delaware]. If any of * * * [Delaware's] assets shall not have been reduced to cash prior to the date of such distribution, which shall take place on May 1, 1956, if not earlier, undivided interests in such assets shall be distributed to the shareholders or such assets shall be otherwise divided ratably among the shareholders of * * * [Delaware]. Such distribution of all of the assets of * * * [Delaware] shall be in complete cancellation of all outstanding shares of * * * [Delaware].
* * * * * * *
Dated at San Francisco, California, June 14, 1955.
On June 17, 1955, there was incorporated West Coast Terminals Co. of California, a California corporation (hereinafter referred to as California). California had only one class of stock. It issued this capital stock on July 15, 1955, and received full payment therefore in cash in the aggregate amount of $300,000.
Certain employees, important in the operation of the business and who had not owned any stock in Delaware, became stockholders in California. These persons consisted of M. O. Kurtz, the secretary and treasurer of Delaware, who was in charge of its accounting, A. E. Johnson, who was terminal superintendent for southern California, O. Johnson, who was superintendent of stevedoring operations in San Francisco, L. B. Kavanaugh, who was terminal superintendent in San Francisco, N. R. Linden, who was superintendent of stevedoring operations at Terminal Island in Los Angeles harbor, G. F. Cervelli, who was terminal superintendent at San Francisco, and James O'Leary, who was terminal superintendent at San Francisco.
The capital stock of California at all material times has been owned, by petitioners and others, as shown by the following schedule: Percentage Shares Stockholders of stock of stock
Bush, W. J. .......................... 30 900 Gallagher, J. C. ..................... 21 630 Cuffe, T. E. ......................... 10 300 Grant, G. H. ......................... 6 2/3 200 Burkman, D. R. ....................... 5 150 ------- ----- Total ........................... 72 2/3 2,180 Kurtz, M. O .......................... 5 150 Johnson, A. E ........................ 4 2/3 140 Johnson, O ........................... 4 2/3 140 Kavanaugh, L. B ...................... 4 2/3 140 Linden, N. R ......................... 4 2/3 140 Cervelli, G. F ....................... 1 5/6 55 O'Leary, J ........................... 1 5/6 55 ------- ----- Total 27 1/3 820 Grand total 100.00 3,000 On July 18, 1955, Delaware effected a sale of all of its operating assets and prepaid expenses and an assignment of its current trade contracts to California. The consideration for the above purchase was a check dated July 18, 1955, for the book value of the property in the amount of $100,264.56, said to be the fair market value of the properties. Nothing was paid for the partially performed contracts with customers beyond the purchaser's assumption of the obligations of these contracts. The opening balance sheet of California on July 18, 1955, was set up on the books as follows:Assets:
Tangible Property ...................... $100,264.56 Cash ................................... 199,735.44 ------------ Total .................................. $300,000.00 ============ Liabilities .............................. 0 Capital Contributed ...................... $300,000.00 Retained Earnings ........................ 0 ------------ Total .................................. $300,000.00 ============
This amount is allocable in the amounts set forth below, and such amounts were the current fair market value of the properties owned:
San Francisco pier, wharfage, automobiles, trucks, tractor equipment............... $52,075.74 San Francisco furniture and fixtures...... 8,481.95 Long Beach pier, wharfage, automobiles, trucks, tractor equipment............... 20,328.85 Long Beach furniture and fixtures......... 9,491.65 Prepaid insurance......................... 9,886.37 Contracts................................. 0 ---------- 100,264.56
In all cases the assignment of the contracts was agreed to by the third party involved, except in the case of the United States Government, which required that a new contract in the form of a novation be entered into. In securing these assignments, the customers were informed that the same key personnel would be with California and that Bush and Gallagher would control the company. A new licensing agreement with the Board of State Harbor Commissioners for the use of pier facilities was also entered into by California.
After July 18, 1955, Delaware completely terminated its business, retaining only the personnel and office facilities necessary to effect an orderly liquidation. After July 18, 1955, the principal assets remaining to be converted to cash by Delaware were its accounts receivable. On July 21, 1955, Delaware was issued a document entitled "Certificate of Dissolution" by the State of Delaware.
By May 3, 1956, Delaware had made a series of distributions of all remaining assets to its shareholders pro rata, as shown by the following schedule:
Payments Payments Total Shareholder Shares Payments 1956 1956 payments 1955 In cash In kind Bush ......... 391 $302,397.53 $13,607.89 $10,136.75 $326,142.17 Cuffe ........ 267 206,496.51 9,292.34 6,922.09 222,710.94 Gallagher .... 58 44,856.93 2,018.56 1,505.09 48,380.58 Grant ........ 57 44,083.54 1,983.76 1,474.92 47,542.22 Burkman ...... 28 21,655.06 974.48 727.40 23,356.94 Sexton ....... 267 206,496.51 9,292.34 6,922.09 222,710.94 Seid ......... 75 58,004.64 2,610.21 1,944.22 62,559.07 Lyon ......... 75 58,004.64 2,610.21 1,944.22 62,559.07 Seidenspinner 75 58,004.64 2,610.21 1,944.22 62,559.07 ----- ------------- ---------- ---------- ------------- Total ... 1,293 $1,000,000.00 $45,000.00 $33,521.00 $1,078,521.00 After these distributions, Delaware had no remaining assets and all of its outstanding shares of stock were surrendered and canceled.Delaware's total accumulated earnings and profits since its organization did not exceed $949,221, and petitioner's respective shares thereof did not exceed the following:
Bush ................................... $287,044.30 Cuffe .................................. 196,014.14 Gallagher .............................. 42,620.02 Grant .................................. 41,860.65
Petitioners' respective shares of Delaware capital and the individual adjusted basis for Federal income tax purposes were as follows: Capital Basis
Bush .................................... $39,100 $59,209.36 Cuffe ................................... 26,700 26,700.00 Gallagher ............................... 5,800 15,206.00 Grant ................................... 5,700 14,943.82As of May 31, 1955, Delaware had retained earnings of $838,329.80 and capital contributed in the amount of $156,000. The annual net income earned and dividends paid by Delaware and California for the following fiscal years was:
DELAWARE Fiscal year ended May 31 Year Net income Dividends for year paid 1947 ......................................... $56,858.57 1948 ......................................... 53,726.83 1949 ......................................... 12,160.78 1950 ......................................... 92,725.83 1951 ......................................... 139,401.41 1952 ......................................... 126,262.08 1953 ......................................... 124,877.88 $50,700 1954 ......................................... 252,662.95 51,720 1955 ......................................... 219,689.91 5-3-56 ....................................... 84,152.59 CALIFORNIA Fiscal year ended June 30 1956 ......................................... $320,704.01 1957 ......................................... 307,021.85 $30,000 The book value of the stock of Delaware on May 31, 1955, shortly before the date of dissolution, was $9,943.30 per 1 percent of stock ownership. The cost of the original issue of the stock of California paid in by its stockholders was $3,000 per 1 percent of stock ownership.The business of the two corporations required only a small amount of operating assets. The operating assets consisted largely of trucks, cranes, fork lifts, and similar vehicles and gear necessary for the loading and unloading of ships and the handling of cargo. This equipment and gear had originally been bought second-hand and about 90 percent of it was over 10 years old. California was required by its business needs to invest in many new operating assets in order to replace old and worn-out assets. Neither Delaware nor California owned real property. They occupied as lessee or licensee those premises on which they conducted business, including piers, terminal facilities, warehouses, offices, and similar property.
The principal business of California was substantially the same as that of Delaware. When California commenced operations in 1955, the use of a name similar to that of Delaware was convenient for the purpose of indicating the same personnel of directors and executives, but was not necessary.
This business was subject to risks in that contracts could be canceled on 30 to 60 days' notice. The executives were important because of their personal contact with the customers and because they had made the contracts. About eight customers accounted for 75 percent of Delaware's business. One of these customers was the United States Army, which accounted for more than 40 percent of Delaware's business. This contract was let by competitive bidding each year and was subject to renegotiation of the profit. Late in 1955, the Army, which had up to then furnished all the gear for work under its contract, was discussing the proposed requirement that the successful bidder furnish the gear commencing January 1, 1956, a requirement which, together with the necessity of replacing the other gear, made the future appear to require an outlay of nearly half a million dollars for gear without any certainty that Delaware would be the successful bidder for the Army contract. At the beginning of 1956, California lost the Army contract.
The monthly operating expense of the business was approximately $1 million. The largest single item was the payroll, which was paid weekly. Each week the executives would estimate the company's payroll and its available cash and the accounts receivable that would be collected during the week. They would then borrow from the bank any additional cash that would be necessary to meet the payroll.
Edwin E. Adams, president of the Bank of California, was a director in both Delaware and California. Both Delaware and California obtained financing exclusively from the Bank of California. Continuous lines of credit in excess of $750,000 were granted by the bank to both corporations. Neither corporation had any difficulty in obtaining loans and on occasion they would be granted an increase in their line of credit on a temporary basis.
Collection of the commercial accounts receivable took an average of 30 to 45 days. On two occasions, California suffered large bad debt losses.
Throughout the 4 fiscal years immediately preceding May 31, 1955, the earned surplus was invested in assets required by business needs. The cash in the business was enough to meet approximately 1 week's operating expenses. Bush had sought counsel as to Delaware's dividend policy with respect to the accumulated earnings tax for each of the fiscal years during 1953 through 1955 and was advised that it was not necessary to have a dividend in either 1953, 1954, or 1955 as long as the first distribution in dissolution was made before August 15, 1955. Adams opposed any dividends and wanted Delaware to build its net worth to reduce the risk of borrowing.
The following were some of the corporate business reasons for liquidating Delaware: To eliminate the inactive estates and widows, representing 38 percent of the outstanding stock, from the business; to permit Gallagher to acquire more stock so that Bush and Gallagher could control the business; to bring into stock ownership seven or eight executives who had helped in making a success of Delaware; to limit Cuffe's ownership of the business. Cuffe had previously withdrawn his account in San Francisco and stated his intention of going into the stevedoring business. The liquidation was intended to limit the possibility of Cuffe's 20.65 percent being combined with the estates and widows to control the business.
The dissolution of Delaware, incorporation of California, and transfer of the assets were all part of a single plan formulated by petitioners upon the advice of their attorney and tax counsel to effect the stated ends and achieve favorable tax results.
The following schedule shows, for each shareholder, the total amount received from the liquidation of Delaware and the total amount invested upon the incorporation of California:
DELAWARE Shareholders -------------------------------------- Shares Percentage Dollars Bush ................ 391 30.24 $326,142.17 Gallagher ........... 58 4.49 48,380.58 Cuffe ............... 267 20.65 222,710.94 Grant ............... 57 4.41 47,542.22 Burkman ............. 28 2.16 23,356.94 ------ ---------- ----------- Total ........... 801 61.95 668,132.85 Sexton .............. 267 20.65 222,710.94 Seid ................ 75 5.80 62,559.07 Lyon ................ 75 5.80 62,559.07 Seidenspinner ....... 75 5.80 62,559.07 ------ ---------- ----------- Total ......... 492 38.05 410,388.15 Kurtz ............... _______ __________ ____________ Johnson, A.E. ....... _______ __________ ____________ Johnson, O. ......... _______ __________ ____________ Kavanaugh ........... _______ __________ ____________ Linden .............. _______ __________ ____________ Cervelli ............ _______ __________ ____________ O'Leary ............. _______ __________ ____________ ------- ---------- ------------ Total .......... _______ __________ ____________ Grand Total ......... 1,293 100.00 $1,078,521.00 CALIFORNIA Shareholders ---------------------------------- Shares Percentage Dollars Bush ................ 900 30 $90,000 Gallagher ........... 630 21 63,000 Cuffe ............... 300 10 30,000 Grant ............... 200 6 2/3 20,000 Burkman ............. 150 5 15,000 ---------- ----------- -------- Total ........... 2,180 72 2/3 218,000 Sexton .............. __________ __________ _________ Seid ................ __________ __________ _________ Lyon ................ __________ __________ _________ Seidenspinner ....... __________ __________ _________ ---------- ---------- --------- Total ......... __________ __________ _________ Kurtz ............... 150 5 15,000 Johnson, A.E. ....... 140 4 2/3 14,000 Johnson, O. ......... 140 4 2/3 14,000 Kavanaugh ........... 140 4 2/3 14,000 Linden .............. 140 4 2/3 14,000 Cervelli ............ 55 1 5/6 5,500 O'Leary ............. 55 1 5/6 5,500 ---------- ---------- --------- Total .......... 820 27 1/3 82,000 Grand Total ......... 3,000 100.00 $300,000 None of the shareholders of Delaware and none of the shareholders of California occupied a relationship to any other shareholder of either Delaware or California, either by reason of being a member of a family or of owning any interest in any partnership, estate, trust, or corporation or for any other reason which would make applicable the constructive ownership rules of section 318 of the Internal Revenue Code of 1954, except to the extent that husband and wife owned shares as community property. All of the stock of each petitioner here involved had been held for more than 6 months before January 1, 1955.Petitioners, in their individual returns, treated the liquidating distributions of Delaware as part or full payment in exchange for their stock and reported the amounts received in excess of the adjusted basis as long-term capital gains. Respondent, in his deficiency notices, "determined that the amount[s] * * * received * * * from [Delaware] * * * [are] taxable in full as dividend income."
OPINION.
Respondent's position consists of two alternative contentions which are so mutually exclusive as to make it desirable to consider them separately. His first argument, as stated in his brief, is "predicated basically on the thesis that the facts show that a complete [or partial] liquidation did not in substance occur." He therefore insists that the amount received by the individuals consisted of a dividend within the purview of section 301 of the 1954 Code. Although he does not specifically refer to section 302, the implication appears to be that the redemption, which he does not dispute, was essentially equivalent to a dividend under section 302(b)(1), see Neff v. United States, 305 F.2d 455 (Ct.Cl. 1962), vacating and withdrawing 301 F.2d 330 (Ct.Cl. 1962), and hence is not to be treated as a capital transaction under section 302(a), but as a dividend under section 301(c)(1), with ordinary income consequences. His alternative argument is that this was a reorganization within the meaning of section 368, that presumably the proceeds of the redemptions constituted "boot," and, accordingly, under section 356, are, at least to some extent, to be treated as ordinary income.
His brief states: "The entire amount received by petitioners upon 'liquidation' of the Delaware corporation constituted a dividend within the purview of Section 301."
According to his brief, "The liquidation distributions are in reality dividends to petitioners and taxable as ordinary income." And, "If the transfers [presumably upon redemption] have the effect of a dividend taxable as a distribution under Sec. 301, the entire amounts received are taxed as ordinary income."
SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.
(b) REDEMPTIONS TREATED AS EXCHANGES. —
(1) REDEMPTIONS NOT EQUIVALENT TO DIVIDENDS. — Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.
SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.
(a) GENERAL RULE. — If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.
SEC. 301. DISTRIBUTIONS OF PROPERTY.
(c) AMOUNT TAXABLE. — In the case of a distribution to which subsection (a) applies —
(1) AMOUNT CONSTITUTING DIVIDEND. — That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income.
SEC. 316. DIVIDEND DEFINED.
(a) GENERAL RULE. — For purposes of this subtitle, the term "dividend" means any distribution of property made by a corporation to its shareholders —
(1) out of its earnings and profits accumulated after February 28, 1913, or
(2) out of its earnings and profits of the taxable year * * *
As he says in his brief: "It is true that the respondent in the instant case does take the position that the Delaware corporation in substance was never liquidated, but was merely reorganized as a California corporation."
SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.
(a) REORGANIZATION. —
(1) IN GENERAL. — For purposes of parts I and II and this part, the term "reorganization" means — Continued on following page.
* * * * * * *
(C) the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of substantially all of the properties of another corporation, but in determining whether the exchange is solely for stock the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded;
(D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356;
(E) a recapitalization; or
(F) a mere change in identity, form, or place of organization, however effected.
SEC. 356. RECEIPT OF ADDITIONAL CONSIDERATION.
(a) GAIN ON EXCHANGES. —
* * * * * * *
(2) TREATMENT AS DIVIDEND. — If an exchange is described in paragraph (1) but has the effect of the distribution of a dividend, then there shall be treated as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be treated as gain from the exchange of property.
There can be no doubt that the stock of Delaware was redeemed and, if that were all there was to it, we might look to section 302, and then to section 301, for guidance in settling the ordinary-income problem. But the redemption was only one step in what was undoubtedly a liquidation-reincorporation operation, see David T. Grubbs, 39 T.C. 42 (1962), as respondent himself suggests in his second alternative.
SEC. 317. OTHER DEFINITIONS.
(b) REDEMPTION OF STOCK. — For purposes of this part, stock shall be treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.
As to the first proposition, we are accordingly able to resort to the step-transaction theory and to view the entire series of transactions as interrelated and inextricable.
It is well settled that where a transaction is comprised of a series of interdependent steps, that is to say, where the legal relationships created by any one step would have been fruitless without the completion of the entire series, the various steps are to be integrated into one for the purpose of arriving at the tax consequences of the transaction. * * * Where the facts warrant the integration of a series of steps into one, it is the situation at the beginning and at the end of the series which determines whether there has been a statutory reorganization, or merely a taxable exchange.
Southwell Combing Co., 30 T.C. 487, 497-498 (1958). Respondent does not, in fact, suggest anything to the contrary, but merely contends that some of the steps actually taken can be disregarded. But, at least in such a situation as this, we cannot justify the inclusion of some and the exclusion of other essential steps.
"Furthermore, the 27 1/3% [%] stock interest purchased in the new corporation by third parties should be disregarded and reorganization treatment applied to the step transaction. This step can be disregarded since without it the dominant purpose — to withdraw corporate earnings while continuing the equity interest in substantial part — was fully achieved."
It is contended by petitioners that the cash distribution was in partial liquidation of the Bessemer Co. and was a part of the plan of liquidation of that company, but that it was not a part of the plan of reorganization. We agree with the first part of petitioners' contention, but do not agree that the cash distribution was not a part of the plan of reorganization.
R. C. Love, 39 B.T.A. 172, 178 (1939), affd. 113 F.2d 236 (C.A. 3, 1940).
The concept of a continuation of the existing business through a section 331 liquidation, coupled with an intercorporate transfer, falls into the general area of corporate reorganizations, so that it is in the so-called reorganization sections, if anywhere, that we should expect it to be dealt with.
See footnote 28, infra.
The fact that the assets of a business are transferred to a new corporation does not by itself change the effect of the liquidation of the original corporation. If, for example, the assets had been transferred to another corporation in which the old shareholders had no interest, even though the business continued, Fowler Hosiery Co., 36 T.C. 201 (1961), affd. 301 F.2d 394 (C.A. 7, 1962); or if they had been transferred to another corporation, but the old corporation's business had not been continued, it seems clear respondent would have had no possible ground for contending that the liquidating distribution, even though partly composed of accumulated earnings, could be taxed as an ordinary dividend. Hellmich v. Hellman, 276 U.S. 233 (1928). So that it is only the continuance of the business in a new corporation, preponderantly owned by the shareholders of the old, upon which respondent can rely for his first contention.
SEC. 331. GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS.
(b) NONAPPLICATION OF SECTION 301. — Section 301 (relating to effects on shareholder of distributions of property) shall not apply to any distribution of property in partial or complete liquidation.
But, generally speaking, it is exactly where the same enterprise is in essence wholly or partly continued even after some more or less radical change in its organization or conduct that it is the purpose of the so-called "reorganization" section of the law to operate. The basic approach of the complicated series of enactments incorporated in the 1954 Code appears to be that all such situations are to be tested by the "reorganization" portion of the statute, and that it was intended that if a transaction of a similar kind does not fall within them, but lies in the general area of arrangements which may, in effect, constitute the continuation of an existing business, it shall be treated as a transaction giving rise to gain or loss and not as a distribution.
Income Tax Regs.
Sec. 1.368-1 Purpose and scope of exception of reorganization exchanges.
(b) Purpose. * * * The purpose of the reorganization provisions of the Code is to except from the general rule certain specifically described exchanges incident to such readjustments of corporate structures made in one of the particular ways specified in the Code, as are required by business exigencies and which effect only a readjustment of continuing interest in property under modified corporate forms. * * *
S. Rept. No. 1622, to accompany H.R. 8300 (Pub.L. 591), 83d Cong., 2d Sess., pp. 43, 230 (1954):
"Your committee has also structurally revised the first three parts of the subchapter. Under your committee's bill, part I of the subchapter contains rules primarily devoted to the treatment of current distributions by a corporation, and does not contain rules with respect to distributions pursuant to a recapitalization or other type of reorganization. Part II, as under the House bill, contains rules relating primarily to liquidations. Part III relates only to reorganizations and includes their effects on the shareholders.
* * * * * * *
"Part I of subchapter C provides rules relating to the tax treatment to shareholders of corporate distributions of property. While your committee continues the treatment provided in the House bill under which part I has no application at the corporate level to distributions of property in complete or partial liquidation, your committee's bill, unlike the House bill, does not include in part I rules for distributions made in connection with corporate reorganizations. Under your committee's bill, distributions and exchanges made in connection with reorganization transactions are treated, in general, in part III."
[Emphasis added.]
Respondent's first contention includes the insistence that we should ignore the liquidation of Delaware and test these transactions solely as a redemption. Yet he makes no reference in his brief to section 302 which is the primary redemption section. It is not clear whether for this proposition he relies on the rationale of such cases as Bazley v. Commissioner, 331 U.S. 737 (1947), rehearing denied and prior opinion amended 332 U.S. 752 (1947); see also Gregory v. Helvering, 293 U.S. 465 (1935), although there it was a "recapitalization," not a liquidation, that was held not to fall within the statute. In Bazley, the Supreme Court found that a transaction which literally complied with the reorganization provisions was not to be accorded reorganization treatment because it was primarily a vehicle for the distribution of undistributed earnings. Gregory similarly denied the benefits of the reorganization provisions to a plan which met the literal definition of the Code because the plan had no relation to the business of either corporation.
We emphasize that the partially performed contracts of Delaware which were transferred to California with its other remaining assets are not treated by respondent as in any respect giving rise to ordinary income to Delaware. Jud Plumbing Heating, Inc., 5 T.C. 127 (1945), affd. 153 F.2d 681 (C.A. 5, 1946); Commissioner v. First State Bank, 168 F.2d 1004 (C.A. 5, 1948), reversing 8. T.C. 831 (1947), certiorari denied 335 U.S. 867; H. B. Snively, 19 T.C. 850 (1953), affd. 219 F.2d 266 (C.A. 5, 1955). The contracts were valued by the parties as being worth nothing. Respondent does not attack their action in this respect. We accordingly express no opinion upon this aspect of the entire transaction.
Respondent would have us hold here that the liquidation of Delaware was not a liquidation, although it literally complied with all the terms, because the transaction is alleged to have been primarily a vehicle for the distribution of undistributed earnings. But, unlike the reorganization sections which were involved in Bazley and similar cases, liquidation is usually accompanied by some kind of distribution which may well include accumulated earnings of the liquidating corporation. Hellmich v. Hellman, supra. That this is recognized by the statutory provisions themselves seems to us to permit of no uncertainty. Even though respondent from time to time refers to the section relating to complete liquidation, no definition of this term appears in the statute nor in the regulations. A complete liquidation of a corporation can apparently exist only where the definition of partial liquidation does not apply, since otherwise there would be no purpose in distinguishing between complete and partial liquidation as defined in section 346(a)(1); although, of course, there may be situations in which, since the result would be the same, it is unnecessary to determine whether the liquidation is complete or partial.
See footnote 14, supra.
SEC. 331. GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS.
(a) GENERAL RULE. —
(1) COMPLETE LIQUIDATIONS. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock.
Instead, it appears that what actually occurred here must be treated as a partial liquidation since it falls squarely within the definition of such a transaction which does appear in the statute. It is difficult to find any ground for holding that this was not in every respect a partial liquidation to which section 331(a)(2) would expressly apply.
SEC. 346. PARTIAL LIQUIDATION DEFINED.
(a) IN GENERAL. — For purposes of this subchapter, a distribution shall be treated as in partial liquidation of a corporation if —
(1) the distribution is one of a series of distributions in redemption of all of the stock of the corporation pursuant to a plan; or
(2) the distribution is not essentially equivalent to a dividend, is in redemption of a part of the stock of the corporation pursuant to a plan, and occurs within the taxable year in which the plan is adopted or within the succeeding taxable year, including (but not limited to) a distribution which meets the requirements of subsection (b).
For purposes of section 562(b) (relating to the dividends paid deduction) and section 6043 (relating to information returns), a partial liquidation includes a redemption of stock to which section 302 applies.
SEC. 331. GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS.
(a) GENERAL RULE. —
* * * * * * *
(2) PARTIAL LIQUIDATION. — Amounts distributed in partial liquidation of a corporation (as defined in section 346) shall be treated as in part or full payment in exchange for the stock.
Section 331(a)(2) of the 1954 Code provides that amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. This carries as a natural corollary that such amounts shall not be treated as dividends.
Fowler Hosiery Co., supra at 222.
We think it follows that the distributions made by Delaware are governed by the rules established by section 346. There was unquestionably a series of distributions in complete redemption of all of Delaware's stock pursuant to a plan. Although these distributions completely liquidated Delaware, the transaction literally falls within section 346(a)(1).
The conclusion that the redemption of Delaware's stock in the course of its liquidation is not to be considered as an ordinary dividend is fortified by an examination of the provisions of section 346. From the language of section 346(a), it would appear that a distribution in redemption of all of the stock of the corporation pursuant to a plan can never be essentially equivalent to a dividend as referred to in section 302(b)(1). This is because Congress found it necessary to include that condition in section 346(a)(2), which refers to the redemption of a part of the stock of the corporation, but omitted it in section 346(a)(1). We cannot assume that this was without significance.
See footnote 20, supra.
Compare section 346(a)(1) (footnote 20, supra) with section 115(g)(1) of the 1939 Code:
SEC. 115. DISTRIBUTIONS BY CORPORATIONS.
(g) REDEMPTION OF STOCK. —
(1) IN GENERAL. — If a corporation cancels or redeems its stock * * * in such manner as to make the distribution and cancellation or redemption * * * essentially equivalent to the distribution of a taxable dividend, the amounts so distributed * * * shall be treated as a taxable dividend.
Furthermore, "Section 302 does not apply to that portion of any distribution which qualifies as a distribution in partial liquidation under section 346." Sec. 1.302-1(a), Income Tax Regs. Not only this, but we have been referred to no authority, either under the 1954 Code or under the less restrictive language of the preceding revenue acts, in which a liquidation-reincorporation has been held to give rise to ordinary income, except where that result could be accomplished by applying the provisions relating to reorganizations. Cf. Richard H. Survaunt, 5 T.C. 665 (1945), affirmed on this issue 162 F.2d 753 (C.A. 8, 1947); Estate of John B. Lewis, 6 T.C. 455 (1946), affd. 176 F.2d 646 (C.A. 1, 1949).
Of course, this does not eliminate respondent's second argument contending for the existence of a reorganization and accompanying "boot." With the limited exception of special situations specifically provided for by statute, see, e.g., sections 333, 341, this would be the only time a series of redemptions of all the stock of a corporation pursuant to a plan, or distributions in complete liquidation of a corporation, would receive treatment as a distribution to which section 301 applies. When the redemption, whether in complete or partial liquidation, is in pursuance of a plan of reorganization, as defined by section 368, and section 356 regarding "boot" comes into play, it is apparent that the dividend provisions of section 301 must apply.
This seems to be respondent's view also. He says in his reply brief:
"* * * The business enterprise may, because of many factors, be subject to change in its form. Where this does not result in a cessation of such business enterprise or a significant diminution in the relationship between the stockholders and their corporate enterprise, a change in the form of the corporate enterprise is not itself considered to be a proper event for taxation; section 368. Any earnings withdrawals in connection with such a mere change in the form of the corporate enterprise are to continue to be subject to the ordinary income rates; 356 and 301."
The difficulty is that this series of steps does not amount to a statutory reorganization. Although several cases have found reorganization upon similar facts under subsection (D) relating to intercorporate transfers of assets with retention of "control," see, e.g., Heller v. Commissioner, 147 F.2d 376 (C.A. 9, 1945), affirming 2 T.C. 371 (1943), certiorari denied 325 U.S. 868; William M, Liddon, 22 T.C. 1220 (1954), affirmed on this issue 230 F.2d 304 (C.A. 6, 1956), certiorari denied 352 U.S. 824; Pebble Springs Distilling Co., 23 T.C. 196 (1954), affd. 231 F.2d 288 (C.A. 7, 1956), certiorari denied 352 U.S. 836, see also Richard H. Survaunt, supra; those cases differ from the instant case in one important respect. Respondent specifically renounces subsection (D). This may be because only 72 2/3 percent of California's stock was owned by former shareholders of Delaware. In this respect, if no other, the present case is unlike David T. Grubbs, supra. "Since the [shareholders of the transferor] owned less than 80 percent of the stock of the new corporations, the acquisition of the assets of the [transferor] is precluded from being a tax-free reorganization within the meaning of section [368(a)(1)(D)]." Austin Transit, Inc., 20 T.C. 849, 856 (1953).
The step-transaction approach makes it possible to view this arrangement as an acquisition of Delaware's assets by California in exchange for California's voting stock to petitioners. But then we must consider that there was also a payment of cash to the retiring 38 percent owned by the estates and widows. Possibly, this is the reason respondent has not attempted to apply subsection (C), relating to the acquisition of assets, "in exchange solely for * * * voting stock." (Emphasis added.) Helvering v. Southwest Corp., 315 U.S. 194 (1942), rehearing denied 315 U.S. 829, second petition for rehearing denied 316 U.S. 710; Turnbow v. Commissioner, 368 U.S. 337 (1961); sec. 368(a)(2)(B), 1954 Code.
The remaining arguments for reorganization treatment are even less persuasive. Respondent's own regulation under section 368, section 1.368-1, 2, Income Tax Regs., disposes of respondent's contention on brief that "Reorganization treatment can be ascribed * * * without literal satisfaction of the requirements of Sec. 368." Furthermore, "there was not that reshuffling of a capital structure, within the framework of an exiting corporation, contemplated by the term 'recapitalization'," as now described in subsection (E). Helvering v. Southwest Corp., supra at 202. (Emphasis added.) And the shift that occurred in the proprietary interest of the two corporations was hardly the " mere change in identity, form, or place of organization" (emphasis added) required by subsection (F). Stollberg Hardware Co., 46 B.T.A. 788 (1942).
E.g., "Sec. 1.368-2 Definition of terms.
"(a) The application of the term 'reorganization' is to be strictly limited to the specific transactions set forth in section 368(a). * * *"
Sec. 368(a)(1)(E), see footnote 9, supra.
Sec. 368(a)(1)(F), see footnote 9, supra.
We rest the conclusion that there was no reorganization here on the form and content of the reorganization sections, not on the ground that there was no business purpose. See Gregory v. Helvering, supra. We have found several valid business motives here for entering into this transaction, the culmination of which achieved the required objectives. Gallagher received more stock, the members of the management who originally had no stock became shareholders, the inactive 38 percent of Delaware stockholders were eliminated from California, and Cuffe's participation in the control of the business was severely limited. While the large accumulated surplus was distributed, we can hardly say that this was entirely, or even substantially, the sole reason for the transaction. The same features held to constitute a business purpose in Marjorie N. Dean, 10 T.C. 19 (1948) (to eliminate inactive women stockholders), and Wolf Envelope Co., 17 T.C. 471 (1951) (to put management in control of the business) exist here.
Section 1.331-1(c), Income Tax Regs., does not interfere with our ultimate conclusion. This regulation adopts the holding of Richard H. Survaunt, supra. In Survaunt, a transaction in which the original corporation was liquidated and the shareholders and directors transferred the assets to a new corporation in exchange for stock was found to be a reorganization under the intercorporate transfer of assets provision of subsection (D) when petitioners failed to prove the absence of a business purpose. The regulation describes similar facts and the underscored language invokes section 356 to cover the distribution of "boot" in pursuance of a plan of reorganization. Since we cannot conclude that the facts in the instant case constitute a reorganization, the reference to section 356 will not support respondent's position.
Income Tax Regs.
See. 1.331-1 Corporate liquidations.
(c) A liquidation which is followed by a transfer to another corporation of all or part of the assets of the liquidating corporation or which is preceded by such a transfer may, however, have the effect of the distribution of a dividend or of a transaction in which no loss is recognized and gain is recognized only to the extent of "other property." See secs. 301 and 356. (Emphasis added.)
Section 1.331-1(c), Income Tax Regs., also cites section 301 as authority. This may be explained as further description of section 356. See section 356(a)(2). Respondent, however, takes the position that the regulation may require dividend treatment in any case of liquidation-reincorporation. It is argued that Congress did not intend a liquidation followed by a reincorporation of the business into a corporation with similar equity interests to be a liquidation within the meaning of section 331, with the result that section 331(b) should not apply. As we have already concluded, however, Congress accorded ordinary income treatment to liquidations only, if at all, in reorganization situations.
See footnote 10, supra.
See footnote 24, supra.
See footnote 14, supra.
We must consequently agree with petitioners. The liquidation of Delaware, although the business was continued by California with considerable change in the corporate structure, falls squarely within the first definition of a partial liquidation. Congress intended that in this situation, any redemption could not be treated as essentially equivalent to a dividend, and that this problem of the continuation of a business must be dealt with, if at all, under the reorganization sections. Since these facts do not fall within the careful language of those sections, the distributions should be treated as payment in exchange for the stock. To find differently would be to enact that provision which has failed on two separate occasions to be enacted by Congress. See H. Conf. Rept. No. 2543, to accompany H.R. 8300 (Pub.L. 591), 83d Cong., 2d Sess., p. 41 (1954), and H.R. 4459, 86th Cong., 1st Sess., sec. 26 (1959). See also Rodman Wanamaker Trust, 11 T.C. 365 (1948), affirmed per curiam 178 F.2d 10 (C.A. 3, 1949); Emma Cramer, 20 T.C. 679 (1953); Trianon Hotel Co., 30 T.C. 156 (1958).
See footnote 20, supra.
"(i) Liquidation followed by reincorporation. — The House bill in section 357 contained a provision dealing with a device whereby it has been attempted to withdraw corporate earnings at capital gains rates by distributing all the assets of a corporation In complete liquidation and promptly reincorporating the business assets. This provision gave rise to certain technical problems and it has not been retained in the bill as recommended by the accompanying conference report. It is the belief of the managers on the part of the House that, at the present time, the possibility of tax avoidance in this area is not sufficiently serious to require a special statutory provision. It is believed that this possibility can appropriately be disposed of by judicial decision or by regulation within the framework of the other provisions of the bill."
We accordingly think petitioners correctly treated the cash and property received from Delaware as a payment in exchange for the Delaware stock redeemed by them. To take account of uncontested adjustments,
Decisions will be entered under Rule 50.
Reviewed by the Court.
WITHEY, J., concurs in the result.
I.
Mr. Justice Cardozo, in delivering the opinion of the Supreme Court in Burnet v. Wells, 298 U.S. 670, said:
One can read in the revisions of the Revenue Acts the record of the government's endeavor to keep pace with the fertility of invention whereby taxpayers had contrived to keep the larger benefits of ownership and be relieved of the attendant [tax] burdens.
* * * At times escape has been blocked by the resources of the judicial process without the aid of legislation. * * * there has been a progressive endeavor by the Congress and the courts to bring about a correspondence between the legal concept of ownership and the economic realities of enjoyment or fruition. * * *
Tax cases in which courts have so used said "resources of the judicial process" to block transparent devices, without the aid of legislation, are numerous. And the methods which the courts have employed in such cases have usually centered: (A) In seeking out the realities and the substance of what actually was done — even though the conclusion reached was inconsistent with the self-serving declarations, forms, and book entries of the party involved; and (B) in then so construing and applying the provisions of the revenue statutes as give effect to their underlying intent and purpose — even in situations where the techniques utilized had been meticulously directed toward bringing the transactions squarely within the literal words or inert language of the statutory provisions. Included among such cases are the following: Helvering v. Gregory, 69 F.2d 809 (C.A. 2), and the Supreme Court's affirming opinion therein, 293 U.S. 465 (wherein the taxpayer was held to have derived a taxable dividend, notwithstanding that she had meticulously sought to bring her transactions within the literal words of the reorganization provisions); Bazley v. Commissioner, 331 U.S. 737 (wherein an alleged "recapitalization" of a business enterprise was rejected, as being "merely a vehicle, however elaborate and elegant, for conveying [corporate] earnings from accumulations to the stockholders"); and Weiss v. Stern, 265 U.S. 242 (wherein it was held that "questions of taxation must be determined by viewing what was actually done, rather than the declared purpose of the participants"). See also in this regard: Helvering v. Clifford, 309 U.S. 331; Burnet v. Wells, supra; Knetsch v. United States, 364 U.S. 361; and Emanuel M. ( Manny) Kolkey, 27 T.C. 27, affd. (C.A. 7) 254 F.2d 51.
As was aptly stated by the Court of Appeals for the Fifth Circuit in the recent case of United States v. General Geophysical Co., 296 F.2d 86, certiorari denied 369 U.S. 849:
tax avoidance implications do not constitute a license to courts to distort the laws or to write in new provisions; they do mean that we should guard against giving force to a purported transfer which gives off an unmistakably hollow sound when it is tapped. * * *
Through all of the above-mentioned cases, there runs a common thread of purpose. In my view, the doctrines embodied therein should have been given effect by this Court in the instant case.
II.
The transactions here involved are typical of a plan which is frequently designated as a "liquidation-reincorporation." The essential feature of such a plan is to split an incorporated business enterprise which in reality continues to carry on an uninterrupted going business, into two separate juristic units through obtaining a new corporate charter; to regard each of such juristic units as a separate "taxpayer"; and then to draw off the accumulated earnings and profits that are segregated into one of the juristic units, as distributions in "liquidation," with a view to obtaining the benefit of having the same regarded as capital gains, rather than as ordinary dividends.
Such "liquidation-reincorporation" device was given attention by Congress during its enactment of the Internal Revenue Code of 1954 and it was there regarded as an avenue for tax avoidance. The House Bill for said Code (in section 357 thereof) originally contained a special statutory provision designed to block such device; but later, this provision was eliminated with the explanation that the possibility of such tax avoidance could "appropriately be disposed of by judicial decision or by regulation within the framework of the other provisions of the bill." (Emphasis supplied.) And thereupon, the Treasury gave effect to such Congressional suggestion, by so wording its regulations pertaining to corporate liquidations (Income Tax Regs., sec. 1.331-1(c)) as to provide that where a "liquidation" is either followed or preceded by a transfer of all or part of the assets of the "liquidating" corporation, such transfer "may have the effect of the distribution of a dividend." See also with regard to such device, the article by Ralph S. Rice in 8 Stanford Law Review 258 (1956), entitled "When Is a Liquidation Not a Liquidation for Federal Tax Purposes?"
H. Conf. Rept. No. 2543 to accompany H.R. 8300, 83d Cong., 2d Sess., p. 41.
In the instant case what happened, in substance, was this. The business enterprise had been incorporated in 1946 under a Delaware charter, to engage in business as a stevedoring contractor in the San Francisco area. Its operations proved to be very successful; and up until the close of its fiscal year ended in May 1955, its aggregate annual incomes totaled more than $1 million. But it had paid dividends in only 2 years, with the result that it had accumulated earnings and profits aggregating between $800,000 and $900,000, as compared with paid-in capital of only $156,000.
There are indications in the record that the retention of this large accumulation of earnings and profits was not necessary to the operations of the business. The company owned no plant or real estate, but performed most of its contractual services while operating as a licensee on ship wharves owned by others. The tools employed in rendering its services consisted principally of cranes, trucks, and other cargo-handling equipment — most of which it had acquired in secondhand condition and were about 10 years old. Collections for the cargo-handling services were normally received within about 30 to 45 days after completion of the work. And the principal expense incurred in the interim was the weekly payroll for the stevedores and other employees, which normally was met through use of a line of credit arranged with a San Francisco bank. As early as 1953, the president of the company conferred with an attorney regarding the possibility of penalties being imposed under the Federal tax statutes, by reason of said large accumulation of earnings and profits; but nothing was then done with respect to the matter. Also it is to be observed that, even after the distribution of over $1 million (here in dispute) was made in 1955 and 1956, the business continued to produce even larger annual net incomes than had been produced in any previous taxable year.
By 1955, there were two new developments, each of which pertained principally to the shareholders as distinguished from the company's own business operations. Certain shareholders who formerly had been active in the business had died; and their shares had passed into the hands of estates and widows who desired to have their equities redeemed. And, there were certain employees of the company who desired to make stock investments in the profitable enterprise. Both of these new developments might have been met without making any changes or substitution of the existing charter, i.e.: By simply redeeming the shares of the estates and widows out of the existing capital and surplus; and by issuing new shares of stock to the employees, either out of the then available unissued corporate stock, or by reissuing the shares redeemed from the estates and widows. But the difficulty of issuing new shares was that, if new stock were sold to the employees before the above-mentioned large accumulation of earnings and profits were paid out as dividends, the price of the shares sold would have to reflect the accumulations. And on the other hand, if the accumulations were first distributed, the result would be that, although the estates and widows who surrendered all their shares through redemption might derive capital gain, the four present petitioners who continued their investments in the enterprise, would unquestionably derive fully taxable dividends. Thus, the real difficulty existing in 1955 was not how to provide for the business needs of the continuing prospering enterprise, but rather how to distribute the large accumulation of earnings and profits without dividend consequences to the four present petitioners.
It was in this situation that there was then developed and put into effect the so-called "liquidation-reincorporation" technique — which the four present petitioners contended was sufficient to enable them to withdraw assets, including their proportionate interests in the large accumulation of earnings and profits, through a purported "liquidation" of the old juristic unit, so as to yield them capital gains, rather than dividends.
III.
In my view, the use of the "liquidation-reincorporation" device in the present case, should have been blocked by this Court through employment of the above-mentioned "resources of the judicial process" — by applying the doctrine of the several authorities cited in the first part of this dissenting opinion.
Here, there was no actual or bona fide "liquidation" of the incorporated business enterprise which had produced the accumulated earnings and profits. Actually, the business was never wound up or discontinued; and the four present petitioners actually never discontinued either their investments or their managerial activities therein. After the acquisition of the new California charter, the going business of the enterprise proceeded as before, without any interruption, under substantially the same name, at the same business locations, rendering services to the same customers under the same contracts, employing the same tools and cargo-handling equipment, and with the same officers and key employees.
As regards the statutes upon which the petitioners have placed reliance, it is significant that the term "liquidation" is not defined therein. In this regard, the situation is similar to that in the Bazley case wherein the Supreme Court pointed out that the term "recapitalization" had not been statutorily defined. The Supreme Court therein stated that in such situation it would not attempt to supply a definition of its own, but rather would determine what does not come within the concept of the term in controversy — by observing the underlying purpose of Congress. The Supreme Court then further said, in speaking of the reorganization provisions of the statute, which it refused to apply in that case:
It was not the purpose of the reorganization provision to exempt from payment of a tax what as a practical matter is realized gain. * * * there are circumstances where a formal distribution * * * represents merely a new form of the previous participation in an enterprise, involving no change of substance in the rights and relations of the interested parties one to another or to the corporate assets. As to these, Congress has said [see as to the 1954 Code, section 368(a)(1)(F) thereof] that they are not to be deemed significant occasions for determining taxable gain.
* * * * * * *
* * * In the case of a corporation which has undistributed earnings, the creation of new corporate obligations which are transferred to stockholders in relation to their former holdings, so as to produce, for all practical purposes, the same result as a distribution of cash earnings of equivalent value, cannot obtain tax immunity because cast in the form of a recapitalization-reorganization. * * * [Emphasis supplied.]
In my view, the present petitioners and also the majority of this Court have placed too much reliance on the shift of the corporate charter from Delaware to California, a change which apparently had no substantial effect on the uninterrupted operations of the going business, and too much reliance also on the fact that certain employees who had not previously been stockholders, invested $82,000 in the profitable business which did not lack or need additional financing. I think rather, that greater emphasis should have centered on the realities of what actually was done; and upon the continuity of the business enterprise in which investments of the present petitioners remained in solution. See in this connection, Helvering v. Gregory, supra, wherein, as hereinbefore pointed out, both the Second Circuit and the Supreme Court disregarded the creation of a new juristic entity, and also declined to apply the reorganization provisions of the statute, in seeking out the reality of what actually had been done. See also, Libson Shops, Inc. v. Koehler, 353 U.S. 382, wherein the "continuity of business enterprise" principle was applied, in lieu of the entity concept which had theretofore been applied by this and other courts in similar cases, in determining whether the "taxpayer" which sought to deduct net operating losses incurred in prior years, was the same "taxpayer" which had sustained such losses. And see further, Huyler's, 38 T.C. 773, wherein this same "continuity of business enterprise" principle was applied by this Court.
It is my opinion that said "continuity of business enterprise" principle should likewise have been applied in the instant case; that the changes made in respect of the present continuing business enterprise were too unsubstantial to have the effect of creating a new and separate "taxpayer"; and that (to use the words of the Supreme Court in the Bazley case) the transactions here involved were "merely a vehicle, however elaborate and elegant, for conveying [corporate] earnings" from accumulations to the present petitioners.
I would have sustained the determinations of the Commissioner that these petitioners realized taxable dividends.
RAUM and ATKINS, JJ., agree with this dissent.