Tennessee Carolina Transp., Inc. v. Commissioner

Tannenwald, J., dissenting: I disagree with the majority’s application of the tax benefit rule to the facts presented herein on the simple ground that there was no recovery within the meaning of the third prong of that rule which I set forth in my concurring opinion in Estate of David B. Munter, 63 T.C. 663, 679 (1975): “(1) An amount previously deducted, (2) which resulted in a tax benefit, and (3) was recovered during the taxable year in issue.” (Emphasis added.) The majority rests its decision on the fiction that petitioner “must * * * be deemed to have received immediately prior to its liquidation, tires and tubes equal in value to those which it distributed.” In other words, the act of disposition itself becomes the equivalent of receipt of the property disposed of, without any corresponding present benefit. I had thought that the use of fictions as a basis for applying the tax benefit rule had been abandoned. Nash v. United States, 398 U.S. 1 (1970). Compare John T. Stewart III Trust, 63 T.C. 682 (1975). See also Estate of David B. Munter, 63 T.C. at 680 (concurring opinion).

In every case cited by the majority, in which the tax benefit rule has been applied, there was a present economic benefit, either by way of an actual receipt of funds or a release of a liability resulting in an increase in the taxpayer’s net worth. In both Bear Manufacturing Co. v. United States, 430 F.2d 152 (7th Cir. 1970), and Mayfair Minerals, Inc., 56 T.C. 82 (1971), affd. per curiam 456 F.2d 622 (5th Cir. 1972), the taxpayer gave recognition in the taxable year to the termination of a liability, which had formed the basis of a deduction in a prior year, by transferring the amount of the liability to surplus, i.e., increasing its net worth. This act of transfer, which made “the money which the [previous] accruals represented * * * available for its general use” (see Mayfair Minerals, Inc., 56 T.C. at 87 ), was held to be the taxable event, i.e., there was a present economic benefit. 1

The only apparent source of authority for a broader reading of the word “recovery” is Estate of William H. Block, 39 B.T.A. 338, 341 (1939), affd. sub nom. Union Trust Co. v. Commissioner, 111 F.2d 60 (7th Cir. 1940), wherein it was said:

Income tax liability must be determined for annual periods on the basis of facts as they existed in each period. When recovery or some other event which is inconsistent with what has been done in the past occurs, adjustment must be made in reporting income for the year in which the change occurs. [Emphasis added.]

Since that case involved an actual recovery in the form of a receipt by the taxpayer of a “refund of the taxes which formed a basis for deductions from its income in prior years,” 39 BiT.A. at 340, the above-emphasized portion of the Board’s opinion is clearly dictum. Moreover, the Board’s language cain be read to embrace those situations where there was no recovery in the sense of an actual receipt of funds by the taxpayer but where there was an “event” which could be equated with recovery such as the termination of a liability, thereby increasing net worth, such as occurred in Mayfair Minerals, Inc., supra.

To the extent that the majority reads the language of Block to sanction the application of the tax benefit rule where the only event is the cessation of need for the prior deduction, its approach is directly contrary to that taken in Nash v. United States, supra, where the Supreme Court categorically rejected the concept that the “end of ‘need’ [was] synonymous with ‘recovery’ in the meaning of the tax benefit rule.” See 398 U.S. at 3 . Indeed, the majority recognizes the difficulty presented by Nash and attempts to distinguish that holding on the ground that the Supreme Court indicated the possibility of applying the tax' benefit rule where the fair market value of the property received by'the taxpayer exceeds the adjusted basis of the property given up and the taxpayer had obtained a tax benefit from the prior deduction of all or part of the original cost. But, such a distinction assumes the critical factor, namely, that there was a recovery, i.e., that the taxpayer received something. In distinguishing Nash, the Court of Appeals in Citizens’ Acceptance Corp. v. United States, 462 F.2d 751, 756-757 (3d Cir. 1972), cited by the majority to support its rationalization of Nash, emphasized this very factor. See also Bishop v. United States, 324 F.Supp. 1105, 1111, 1112 (M.D. Ga. 1971). Unlike the receipt of cash or other property or the release from a liability, a liquidating distribution does not cause a corporate taxpayer to realize any economic benefit. Petitioner herein received only its own stock in return for the distributed property; the value of such stock upon the corporation’s cessation of business and distribution of property is nil. See Commissioner v. South Lake Farms, Inc., 324 F.2d 837, 839 (9th Cir. 1963). See also O’Hare, “Statutory Nonrecognition of Income and the Overriding Principle of the Tax Benefit Rule in the Taxation of Corporations and Shareholders,” 27 Tax L. Rev. 215 , 233-236 (1972).

Two aspects of the instant situation obviously influenced the majority in reaching their conclusion: (1) The feeling that, unless the tax benefit rule is applied, petitioner will have the equivalent of a double deduction and (2) the need to have parity between the applications of sections 336 and 337, 2 a problem which I dealt with extensively in my concurring opinions in Estate of David B. Munter, supra, and John T. Stewart III Trust, supra.

As to the first aspect, since the petitioner realized nothing upon its own liquidation, it cannot be said to have enjoyed any “double deduction.” Compare Bishop v. United States, supra, where, absent the tax benefit rule, a corporation would have twice enjoyed tax benefits where it had realized, but had not recognized, gain from section 337 liquidation sales of inventory and where the cost of the items sold had been deducted from income in previous years under the farm-price inventory method of accounting. See also United States v. Skelly Oil Co., 394 U.S. 678, 684 (1969); Winer v. Commissioner, 371 F.2d 684, 686 (1st Cir. 1967).

To the extent that there is a double deduction herein, it arises from the fact that the distributee corporation appears entitled to expense its stepped-up basis in the tires and tubes. But any advantage to the distributee corporation by reason of a section 334(b)(2) stepped-up basis cannot be charged to the distributor-liquidating corporation. The provisions of section 334(b)(2) merely prescribe the basis of property in the distributee’s hands; that they treat the parent as though it has purchased the assets of the subsidiary does not mean that they alter the tax consequences of a liquidation pursuant to other statutory sections, e.g., by imputing a sale of the property to the liquidated corporation. See Supreme Investment Corp. v. United States, 468 F.2d 370 (5th Cir. 1972); Bijou Park Properties, Inc., 47 T.C. 207, 214 (1966); see also Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 11.44 (3d ed. 1975) (automatic operation of sec. 334(b)(2)). The tax benefit rule does not require one taxpayer to assume a tax liability for benefits accruing to another taxpayer. Commissioner v. South Lake Farms, Inc., supra. Cf. Peter Pan Seafoods, Inc. v. United States, 417 F.2d 670 (9th Cir. 1969).

As far as parity between sections 336 and 337 is concerned, the courts have thus far refrained from embracing any absolute rule. See Commissioner v. South Lake Farms, Inc., 324 F.2d at 839 ; John T. Stewart III Trust, 63 T.C. at 693; Estate of David B. Munter, 63 T.C. at 677. Moreover, it has been pointed out that complete parity between these two sections can never exist because of specific limitations contained in section 337. See Midland-Ross Corp., Tr. of Sur. Com. Corp. v. United States, 485 F.2d 110, 117-118 (6th Cir. 1973). See also Bittker & Eustice, supra, par. 11.65. It cannot be gainsaid that section 337 was enacted to eliminate the judicially created formalisms which made tax consequences turn on a determination whether a corporation in the process of liquidation or its shareholders made the sale of the assets. See S. Rept. No. 1622, 83d Cong., 2d Sess. 48-49 (1954); H. Rept. No. 1337, 83d Cong., 2d Sess. 38-39 (1954). By way of contrast, section 336 represented a legislative confirmation of the longstanding judicial doctrine that a corporation generally does not realize income from a distribution of its assets in kind to its shareholders. See S. Rept. No. 1622, supra at 46; H. Rept. No. 1337, supra at 37-38. Cf. General Utilities & Operating Co. v. Helvering, 296 U.S. 200 (1935). But it does not follow from the fact that section 337 was intended generally to relieve the liquidating corporation of taxability on any gain from the sale of its assets that Congress intended to impose a tax liability (which would not otherwise have been incurred) upon a corporation liquidating in kind under section 336, simply because such liability would have been realized upon a sale of assets otherwise qualifying for nonrecognition under section 337. Section 337 was designed to be a shield for taxpayers and not a sword to be used against them in applying other sections of the Code. I am not unmindful of the fact that there may be a trap for the unwary to the extent that á dichotomy develops between the two sections. But, as I see it, this inheres in the statutory and judicial structure. Compare Waltham Netoco Theatres, Inc., 49 T.C. 399 (1968), affd. 401 F.2d 333 (1st Cir. 1968).

In analyzing the issue before us, I think it is of some significance that the recapture of depreciation deductions which Congress has seen fit to impose in corporate liquidations (see sec. 1245 and sec. 1.1245-4(c), Income Tax Regs.) does not compel recovery of expensed items under like circumstances. In fact, it appears that section 1245 does not extend to expensed as distinguished from depreciable property, cf. Coca-Cola Bottling Co. of Baltimore v. United States, 487 F.2d 528 (Ct. Cl. 1973), a position which is in accord with the concept that a deduction for ordinary and necessary business expenses is not the same animal as a deduction allowed for depreciation. See Pittsburgh Athletic Co., 27 B.T.A. 1074 (1933), affd. 72 F.2d 883 (3d Cir. 1934). 3

If we are to be guided by legislative expression, let it be by section 111, the statutory tax benefit rule. This provision excludes from gross income the amount of a prior deduction later recovered to the extent the earlier deduction did not result in a tax benefit. This provision requires an actual economic recovery and its thrust in terms of the tax benefit rule is one of limitation; it was enacted to “harness the ‘benefit theory’ to a standard formula which could be applied with reasonable uniformity.” See 1 Mertens, Law of Federal Income Taxation, sec. 7.34, n. 38 (Malone rev. 1974). 4 To permit the word “recovery” to take on Procrustean attributes would clearly not serve this purpose.

In sum, I simply cannot find that element of “recovery” herein which the application of the tax benefit rule demands. Similarly, I cannot bring myself to dispense with the “recovery” requirement (or alternatively to find a fictional “recovery”) in order to apply that rule and impute a taxable event to a corporate liquidation in kind under circumstances where such taxability has heretofore not been considered to exist. In this connection, it is interesting to note that this Court, in the past, has refused to activate “the abstract notion of tax benefit” to require a taxpayer to include in income gratuitously canceled interest on his indebtedness, notwithstanding the fact that such taxpayer had accrued and deducted such interest in prior years. Hartland Associates, 54 T.C. 1580, 1586 (1970).

To the extent that petitioner expensed tires and tubes purchased in the year of liquidation, an adjustment should be made in petitioner’s deductions for that year under section 446(b). Spitalny v. United States, 430 F.2d 195, 198 (9th Cir. 1970); Estate of David B. Munter, 63 T.C. at 682 (concurring opinion).

Drennen, Irwin, Sterrett, Quealy, Goffe, and Hall, JJ., agree with this dissent. It should be noted that the expensing of the tires and tubes in previous years in and of itself created no asset or liability which was capable of transfer or whose disposition would have affected the petitioners’ net worth. Cf. Nash v. United States, 398 U.S. 1, n. 4 (1970); Argus, Inc., 45 T.C. 63, 69-70 (1965).

It should be noted that the taxability of the corporation is determined under secs. 336 and 337, whether the liquidation is taxable or tax free to the recipients under secs. 331 through 333.

Compare sec. 1.162-3, Income Tax Regs., with secs. 1.263(a)-l and 1.263(a)-2, Income Tax Regs. See generally Welch v. Helvering, 290 U.S. 111, 113 (1933).

See also H. Rept. No. 2333, to accompany H.R. 7378 (Pub. L. No. 763), 77th Cong., 2d Sess. 45,69-71 (1942).