Petition — Schaffan v. Commissioner
Supreme Court brief1980
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sreme Court, U. & ~
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41 1980
IN THE
Supreme Court of the United Staten.
OctroBer Term, 1979
49-1947
oO.
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Petitioners,
VS.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS FOR THE
THIRD CIRCUIT
Joun J. O’Toorz,
Epwin FRapkKIN,
Counsel for Petitioners,
744 Broad Street,
Newark, New Jersey 07102.
(201) 623-5346
Starr, WEINBERG AND F'RADKIN,
Attorneys for Petitioners.
Adams Press Corp., 5 Commerce Street, Newark, N. J. 07102—(201) 623-8611
k
.
¢ §
A
———- ee
TABLE OF CONTENTS
I a
SE SLE FS Ie ae TST OPER ee ae
ae yea
aps AS.) ee boa
CE RE IN TE On ee ee ee
REASONS FOR GRANTING THE WRIT:
I. The decision of the Court of Appeals appears
to be in conflict with decisions of the Courts
of Appeals of the First, Fourth, Fifth and
Sree: CO a scaceeocasbionn
II. This case presents important questions of
Federal Tax Law which should be resolved by
I I iach csassidnrccticedeanticrtebocicsiccndalanehe
CONCLUSION cceceecceeeeeeee = oe ORE a A
APPENDICES:
A—Opinion of the United States Court of Ap-
peals for the Third Circuit ..............................
B—Order Amending Opinion -...0..0...2........-cesecec-0---
C—Opinion of the United States Tax Court ........
D—Judgment of the United States Court of
Appeals for the Third Circuit
K—Order Extending Time to File Petition for
a Write of Certiorari .........
F—Statutes Involved
G—House Conference Report No. 2543 ................
82a
li TABLE OF CONTENTS
PAGE
Cases Cited
Breech v. U.S., (9th Cir. 1971) 489 F.2d 409 ...00000.2....
Gregory v. Helvering (Sup. Ct. 1935), 293 U.S. 465 .. 7
Lewis v. Commissioner, (1st Cir. 1949) 176 F.2d 646 6
Pridemark, Ine. et al. v. Commissioner, (4th Cir.
PE 5-7
Reef Corp. v. Commissioner, (5th Cir. 1966) 368 F.
2d 1%, cert. dem, Soe US, 1016 ._................................. 6, 7
Ringwalt v. United States, (8th Cir. 1977) 549 F.
y R. Boamenere 5
Statutes Cited
28 U.S.C.:
ee 2
(These are reproduced in the Addendum)
Internal Revenue Code of 1954:
I eT 2,3
COI Ge cin i sacccccccee 2-4
TR 2
a 2.8
Section 368(a)(1)(D) -2....22..2...cece000-e0- a 2,3
Miscellaneous
House Report No. 833 (83rd Congress) ................2..-0--- 5
House Conf. Rep. No. 2543, 83rd Cong. 2d Session
p. 41 (3 USC Cong. and Adm. News (1954) 5280,
5301 5, 7
IN THE
Supreme Court of the United States
Octoser Term, 1979
No.
Ln
—
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Petitioners,
Vs,
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
- =
—_—
PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS FOR THE
THIRD CIRCUIT
Petitioners, Stephan Schaffan and Mildred Schaffan
(hereinafter “taxpayers”) respectfully pray that a writ
of certiorari issue to review the judgment of the United
States Court of Appeals for the Third Circuit entered
on January 28, 1980.
Opinions Below
The opinion of the Court of Appeals, which is not
yet officially reported is annexed hereto in Appendix A.
Annexed hereto in Appendix B is the “Order Amend-
ing Opinion”. The opinion of the United. States Tax
Court, reported in 70 T.C. 86, is annexed hereto in Ap-
pendix C.
Jurisdiction
The judgment of the Court of Appeals, annexed in
Appendix D, was entered on January 28, 1980. On April
29, 1980 Associate Justice William J. Brennan, Jr. en-
tered an order, annexed hereto in Appendix KE, extend-
ing the time within which to file this petition to and
including June 26, 1980. The Jurisdiction of this Court
is invoked under 28 U.S.C. Section 1254/1).
Question Presented
Whether a corporate distribution received by the tax-
payer, Stephan Schaffan, was a distribution in complete
liquidation pursuant to sections 337 and 331 of the In-
ternal Revenue Code of 1954, or a distribution of a dividend
under section 356(a) of the internal Revenue Code as
a result of a liquidation-reincorporation under section 368
(a)(1)(D) of the Internal Revenue Code of 1954.
Statutes Involved
The following sections of the Internal Revenue Code
of 1954: 331, 337, 354, 356, 368(a)(1)(D). These sections
are set forth in Appendix F annexed hereto.
Statement
This case arose as the result of a petition which was
filed by the taxpayers in the United States Tax Court
from a statutory notice issued by the respondent. In the
statutory notice, the respondent determined that a claimed
liquidation under Section 337, supra, of a corporation
known as Fletcher Plastics, Inc. (hereinafter referred to
as Fletcher) which was wholly owned by the taxpayer,
Stephan Schaffan, was in effect a reorganization under
section 368(a)(1)(D), supra. The result of this determina-
tion was that the distribution from Fletcher which the tax-
payer reported under section 331, supra, as a long-term
capital gain was recharacterized as ordinary income re-
sulting from a dividend under Section 356, supra.
This issue of liquidation versus reincorporation arises
out of the factual pattern that the taxpayer (Stephan
Schaffan) was the sole stockholder of two corporations
which prior to the time of the claimed liquidation each
performed specific functions in the overall operation of a
business venture, which was the designing, manufacturing
and selling of components of model railroad ensembles.
The dominant corporation was Atlas Tool Co., Ine. (here-
inafter referred to as Atlas), and the liquidated corpora-
tion was Fletcher. Atlas had since 1924 been a sole pro-
prietorship engaged in the tool and die business. Com-
mencing in 1945, the taxpayer utilized the business solely
for his own purpose and ventured into the model railroad
industry pioneering the development of HO gauge track
(it also manufactured N and O gauge). It became incor-
porated in 1949. Up to the year 1960, Atlas engaged in
two basic lines of operation. It manufactured the compon-
ents for the ensembles, and it also designed, packaged and
sold its products. Also, starting in 1959, it began to im-
port certain components and parts. Schaffan had visited
and investigated foreign manufacturers and he determined
4
that he could supply Atlas’ inventory demands through
foreign imports. The cost was less than domestic manu-
facturing and at that time the quality was acceptable.
The decision was therefore made to concentrate design,
packaging and selling in Atlas and to disassociate it from
domestic manufacturing. Fletcher was incorporated in
1960 to fulfill the decision to phase out manufacturing until
the time when imports could be totally relied upon. In
about 1968, it was determined that the time had arrived
when Atlas could be entirely supplied by foreign imports,
and that Fletcher was no longer necessary and could be
dispensed with as a separate manufacturing entity. It was
not until 1970 that this decision was implemented and it
was decided to liquidate Fletcher. Schaffan’s intention
was to maintain Atlas only for design, packaging and sell-
ing, and no longer to continue the manufacturing activity
which had been concentrated in Fletcher.
In October, 1970, Fletcher filed with the respondent its
election to liquidate its corporate assets under section 337,
supra. Disposal of the machinery presented a problem
as a piece-meal disposition would involve a long period
of time; a market was not available for a bulk sale; and
as used machinery, it would have to be sold at a loss.
Schaffan, as a businessman, anticipated that some catas-
trophe such as a war or strike could interrupt his imports.
Thus, he made a business decision. He had obtained an
independent appraisal in order to offer the machinery for
sale. Based upon this appraisal, Atlas purchased the ma-
chinery in an arms-length transaction, and the machinery
could be retained by it as a hedge against the failure of
foreign imports. For a period of time the machinery was
idle. However, without any anticipation of quality prob-
lems, the imports started to show poor workmanship and
in order to maintain quality control, resort had to be
made to the machinery to manufacture jigs, dies and tools
to repair twisted track. Delays occurred in shipments;
motors in the locomotives burned out and Atlas had to re-
sort to some manufacture,
Respondent determined that the transfer of the machin-
ery to Atlas and its subsequent use, however minimal, sug-
gested a continuation of Fletcher’s business in Atlas, and
thus, constituted a reorganization rather than a liquida-
tion. Reliance was founded upon the line of case law
known as the liquidation-reincorporation doctrine.
The Taxpayers’ position is based upon a valid liquida-
tion under section 337, supra; and, that the liquidation-
reincorporation doctrine is not applicable where there is
no showing of a tax avoidance motive, or a continuation
of a business enterprise, the latter being defined as a “con-
tinuation of an existing business as opposed to the ter-
mination of a going concern”. cf. Jack D. Ringwalt v.
United States (8th Cir, 1977), 549 F.2d 89. In support of
their position the taxpayers stressed that the legislative
history of the Internal Revenue Code of 1954 revealed that
any attempt to circumvent a liquidation revolved around
the concept of tax avoidance, but that Congress did not
legislate in this area leaving it to the judiciary to deter-
mine if there was present the element of tax avoidance,
cf. Pridemark, Inc. v. Commissioner of Internal Revenue
(4th Cir, 1965), 345 F.2d 35, See, H.R. 833 (83rd Cong.) ;
Il. Conf. Rep, No. 2543 (3 U.S.C. Cong. and Adm. News
(1954) 5280, 5301)), attached hereto in Appendix G. In
addition, the taxpayers cited decisions in other jurisdie-
tions which support their arguments both as to tax avoid-
ance and continuity of an existing business,
REASONS FOR GRANTING THE WRIT
I. The decision of the Court of Appeals appears to be
in conflict with decisions of the Courts of Appeal
of the First, Fourth, Fifth and Ninth Circuits.
Taxpayer contended before both the Tax Court and the
Court of Appeals that the judicial theory of liquidation-
reincorporation could not be invoked by the Commissioner
because there was not present a tax avoidance motive, and
a continuity of an existing business between Fletcher and
Atlas. Both lower courts concluded:
(1) That the motive of tax avoidance is not a factor
in the application of the liquidation-reincorporation doce-
trine. In so ruling both Courts ignore precedents in other
Circuits. cf. Pridemark, Inc., et al v. Commissioner of
Internal Revenue, supra; Reef Corp. v. Commissioner of
Internal Revenue, (5th Cir. 1966) 368 F.2d 125, cert. den.
386 U.S. 1018. This is the first occasion the Third Cir-
cuit has been presented with this issue, and it apparently
is in conflict with the Fourth and Seventh Circuits on
this issue. The Cireuit Court did recognize that the Pride-
mark, supra, case is contrary to its holding and noted
such in footnote 10.
(2) That in a “D” type reorganization continuity of
business enterprise does not require a continuation by the
transferee corporation of the business activities of the
transferor corporation. In arriving at this conclusion,
both lower courts ignored precedent of cases in other
Cireuits. cf. Pridemark, Inc. et al v. Commissioner of
Internal Revenue, supra; Lewis v. Commissioner, (1st Cir.
1949) 176 F.2d 646; Reef Corp., supra; Breech vy. U.S.,
(9th Cir. 1979) 439 F.2d 409. The Tax Court recognized
the existence of case law in support of taxpayers’ posi-
tion. Here, also, this is the first occasion for the Third
Cireuit to rule on this issue, and its decision is in con-
flict with the First, Seventh and Ninth Circuits. In foot-
note 10 of its opinion, the Circuit Court also recognized
that the Pridemark, case, supra, rested “in part, on the
lack of continuity of business enterprise due to the sus-
pension of business activity”.
II. This case presents important questions of Federal
Tax Law which should be resolved by this Court.
A. Congress, itself, was sufficiently concerned with the
motive of tax avoidance as an element in the liquidation-
reincorporation area so as to at one time consider specific
legislation. cf H. Conf. Rep No. 2543, supra, (Appendix
G). Yet the Cireuit Court “agreed” with the Tax Court
that a tax avoidance motive is not an element to be con-
sidered. This is an issue which presents a very important
consideration when analyzing the actions of a taxpayer
in structuring his business decision as to whether to
liquidate a going business. If the decision of the Court
of Appeals is to be of precedental value, then a tax-
payer’s motive will be of no concern contrary to the views
of this Court in Gregory v. Helvering, (Sup. Ct. 1935)
293 U.S. 465. This issue deserves consideration by this
Court.
B. The Court of Appeals gives a much narrower inter-
pretation to “business enterprise” than did the Eight Cir-
cuit Court of Appeals in the Ringwalt, supra, case; the
First Cireuit Court of Appeals in the Lewis, supra, Case;
and the Fifth Cireuit Court of Appeals in the Reef, supra,
case. In the administration of tax law, it is necessary
that there be conformity in the application of norms and
concepts, otherwise, endless and unnecessary confusion
prevails in the business community. In order to provide
uniformity, this Court should precisely define the con-
tinuity of enterprise concept.
CONCLUSION
For the above reasons, it is respectfully submitted
that this Petition for a Writ of Certiorari should be
granted.
Respectfully submitted,
Joun J. O”'Toore,
Epwin F Rankin,
Counsel for Petitioners,
Starr, WEINBERG AND F'RADKIN,
Attorneys for Petitioners.
APPENDIX A
Opinion of the United States Court of Appeals for the
Third Circuit
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No 78-2631
ATLAS TOOL CO., INC., Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7633-74)
ATLAS TOOL CO., INC., Successor to
Fletcher Plastics, Inc., Petitioner
Vv.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7634-74)
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Petitioners
Vv.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7635-74)
ATLAS TOOL CO., INC., ATLAS TOOL CO., INC.,
Successor to Fletcher Plastics, Inc.,
STEPHAN SCHAFFAN and MILDRED SCHAFFAN.
Appellants
No. 78-2632
ATLAS TOOL CO., INC., Petitioner
vw.
USER Seeeones OF INTERNAL REVENUE,
Respondent
2a
Appendiz A
(Tax Court Docket No. 7633-74)
ATLAS TOOL CO., INC., Successor
to Fletcher Plastics, Inc., Petitioner
VU.
COMMISSIONER OF INTERNAL REVENUE.
Respondent
‘(Tax Court Docket No. 7634-74)
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Cour. Docket No. 7635-74)
COMMISSIONER OF INTERNAL REVENUE.
Appellant
ON APPEAL FROM THE UNITED STATES TAX COURT
Argued: October 15, 1979
Before: GIBBONS and HIGGINBOTHAM, Circuit Judges
and WEINER, District Judge*
(Opinion Filed: January 28, 1980)
JOHN J. O’TOOLE, ESQ. (Argued)
STARR, WEINBERG and FRADKIN
744 Broad Street
Newark, New Jersey 07102
Attorney for Appellants
in 78-2631
*Hon. Charles R. Weiner, United States District Judge for the East-
ern District of Pennsylvania, sitting by designation.
3a
Appendiz A
M. CARR FERGUSON
Assistant Attorney General
GILBERT E. ANDREWS
ERNEST J. BROWN
JAMES A. RIEDY (Argued)
Attorneys, Tax Division
Department of Justice
Washington, D.C. 20530
_ Attorneys for Appellant
in 78-2632
OPINION OF THE COURT
GIBBONS, Circuit Judge
This case presents cross-appeals from decisions of
the United States Tax Court upholding, in consolidated
cases, a deficiency in federal income tax asserted for the
taxable year 1970 against Stephan and Mildred
Schaffan, a deficiency in accumulated earnings tax
against Atlas Tool Co., Inc. (Atlas) for the fiscal years
ending June 30, 1969 and 1970, and transferee liability
of Atlas for conceded deficiencies in accumulated earn-
ings taxes of Fletcher Plastics, Inc. (Fletcher) for the fis-
cal years ending November 30, 1968, 1969 and 1970.
Stephan Schaffan is the sole stockholder of Atlas a New
Jersey corporation still in existence, and of Fletcher, also
a New Jersey corporation, which was dissolved in 1970.
The deficiency assessed against the Schaffans involves
the tax treatment of over $400,000 in cash distributed to
Schaffan upon the dissolution of Fletcher. The
Schaffans reported this distribution as a long-term capi-
tal gain but the Commissioner of Internal Revenue and
the Tax Court treated it as a dividend, taxable as ordi-
nary income. The individual taxpayers contend that the
1. The decision of the Tax Court is reported at 70 T.C. 86
(1978).
4a
Appendix A
distribution from Fletcher qualified for capital gains
treatment, while the Commissioner urges that the Tax
Court erred in calculating the amount of the dividend,
and that a higher tax is due. Atlas contends that the Tax
Court erred in upholding the accumulated earnings tax
assessed against it, and in imposing transferee liability
on it for Fletcher’s tax obligations. We affirm the Tax
Court in all respects.
I. The Schaffan’s Individual Tax Liability
In October 1970, Schaffan owned all the stock of At-
las and of Fletcher. Atlas was then engaged in the busi-
ness of designing and selling products for the hobby in-
dustry, principally model railroads. Prior to 1960, Atlas
also manufactured such products. In 1960, Fletcher was
incorporated, acquired Atlas’ plastic molding machines,
and thereafter, conducted the manufacturing operations
previously conducted by Atlas. Fletcher occupied one
floor of a building, the balance of which was occupied by
Atlas. Atlas was virtually the only customer of Fletcher.
During the 1960s, Atlas continually increased its
purchase of foreign manufactured components, which
were cheaper than those domestically manufactured.
Eventually, Schaffan decided that the manufacturing
operations being performed by Fletcher were no longer
essential since the same quality components could be
acquired at a lower cost from foreign sources. Accord-
ingly, in October 1970, at the directors’ and
stockholders’ meetings, it was voted that Fletcher liqui-
date in the manner permitted by section 337, 26 U.S.C.
§337 (1976).
On November 5, 1970 Fletcher transferred to Atlas
all its machinery and equipment for an appraised price
of $100,250, and all its inventory for its $14,600 cost.
Fletcher’s only accounts receivable were from Atlas, and
these were paid in full. On November 19, 1970,
Schaffan received from Fletcher a cash distribution of
5a
Appendia A
$482,246.82 which represented all of its remaining as-
sets. Fletcher filed an appropriate Form 966 with the
District Director of its intended section 337 liquidation,
and filed final federal and state tax returns for the fiscal
year ending November 30, 1970. Fletcher was formally
dissolved in June 1971.
The machinery and equipment transferred to Atlas
remained in place in the building otherwise occupied by
Atlas. Fletcher’s former employees were employed by At-
las, initially in its packing and shipping departments.
The machinery and equipment, left in place, was idle for
a time. However, by December 1970, Atlas began expe-
riencing delivery and quality difficulties with its foreign
suppliers, and to keep its inventory adequate it soon
started operating some of the Fletcher machines. By the
end of 1971, all the machinery and equipment acquired
from Fletcher were in operation. ae
On the Schaffan’s 1970 federal income tax return
they reported $400,000 as a distribution from Fletcher in
complete liquidation under section 331, which provides
that “[a]mounts distributed in complete liquidation of a
corporation shall be treated as in full payment in ex-
change for stock.” 26 U.S.C. §331 (1976). They claimed
an adjusted basis of $10,000 for the Fletcher stock, and
paid tax on a long-term capital gain of $390,000. In the
notice of deficiency, the Commissioner asserted that the
amount distributed to Schaffan was actually
$482,246.82 (an amount not contested by the taxpayer)
and that the transaction was not a section 331-337 liqui-
dation, but a reorganization within the meaning of 26
U.S.C. §368(a)(1)(D). Section 368(a)(1)(D) provides
that:
a transfer by a corporation of all or a part of its assets
to another corporation [is a reorganization] if imme-
diately after the transfer the transferor, or one or
more of its shareholders (including persons who
were shareholders immediately before the transfer),
6a
Appendia A
or any combination thereof, is in control of the cor-
poration 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 trans-
ferred are distributed in a transaction which quali-
fies under section 354, 355, or 356;. . .
26 U.S.C. §368(a)(1)(D) (1976). Whether the transac-
tion is characterized as a section 368(a)(1)(D) reorgani-
zation or a section 337 liquidation, there is stil] no gain
or loss recognized to Fletcher on the transfer of its ma-
chinery and equipment to Atlas. But if the transaction
was a reorganization, the distribution by Fletcher to
Schaffan would be covered by the “boot” provision of
section 356, 26 U.S.C. §356 (1976), and thus be treated
as ordinary income rather than as a capital gain pursu-
ant to section 331, 26 U.S.C. §331(a) (1976).
Section 356(a)(2) provides that money distributed
to stockholders in a reorganization shall, to the extent of
the stockholders’ gain, be treated as a dividend out of
earnings and profits of “the corporation.” 26 U.S.C.
§356(a)(2) (1976). The Commissioner contends that
when, as here, there is complete identity of shareholders
in the two corporate parties to a D reorganization, the
earnings and profits of both corporations should be tak-
en into account to determine how much of the cash dis-
tributed by either is the equivalent of a dividend. The
combined earnings and profits of Fletcher and Atlas ex-
ceeded $5 million, and thus the Commissioner proposes
to treat the entire $482,246.82, less Schaffan’s $10,000
basis for his Fletcher stock, as a section 356(a)(2)
dividend.”
2. Alternatively, the Commissioner contended that these
were, in substance, two separate dividend distributions: Schaffan
received a $381,996.82 dividend from Fletcher, and a dividend of
$100,250:from Atlas because the sale of assets was merely an at-
tempt to bail out earnings and profits of Atlas at capital gains rates.
The alternative theory is not pressed here.
Ta
Appendix A
The Tax Court held that the transaction was a D re-
organization, and therefore section 356(a)(2) applied,
but that the dividend treatment was authorized only to
the extent of earnings and profits of Fletcher. It comput-
ed those earnings and profits as $440,342.56, and deter-
mined that the difference between that sum and
$472,246.82 was taxable as a long-terrn capital gain.
The Schaffans contend that the entire $472,262.82 was
a long-term capital gain. The Commissioner contends it
was all a section 356(a)(2) dividend.
We turn first to the Schaffans’ contention. They
point to the adoption by appropriate corporate resolution
of a plan of complete liquidation of Fletcher within
twelve months, to the accomplishment of both the dispo-
sition and distribution of Fletcher’s assets within that
time, and to Fletcher’s dissolution. These events, they
urge, were in full compliance with section 337, which
provides for the nonrecognition of gain or loss on the sale
of Fletcher’s machinery and equipment to Atlas. More-
over, they argue that the distribution is “in complete liq-
uidation” of Fletcher and should, therefore, “be treated
as in full payment in exchange for [Fletcher] stock” pur-
suant to section 331, 26 U.S.C. §331(a)(1) (1976). Tax-
payers contend that in the absence of any proof of an in-
tent to avoid taxes, it was error for the Tax Court to
characterize the transaction as a D reorganization in-
stead of a complete liquidation.
Our starting point is the text of section 368(a)(1)(D)
quoted above. Clearly there was, as that section requires,
a transfer by Fletcher of all or part of its assets—in this
case all its machinery, equipment and inventory were
transferred to another corporation, Atlas. In addition.
Schaffan, the sole stockholder of Fletcher, was in control
of Atlas “immediately after” the transfer. No stock or se-
curities of Atlas were distributed to Schaffan. But de-
spite the language in section 368(a)(1)(D) to that effect.
it has been held that a distribution is not necessary
8a
Appendix A
where the ownership of the transferor and transferee is
identical because such a distribution would be a mere
formality.*
A distribution pursuant to section 368(a)(1)(D)
must also qualify under section 354 or section 355 in or-
der for section 356 to be applicable. Section 355, which
concerns the distribution of stock and securities of a
controlled corporation, does not come into play in the
Fletcher-Atlas transaction. Section 354, however, is ap-
plicable to the facts in this case. It provides for the
nonrecognition of gain or loss on an exchange of stock or
securities solely for stock or securities. Where there is
complete identity of ownership, section 354, like section
368(a)(1)(D), has been construed not to require the
meaningless formality of such an exchange.* However,
section 354(a):
shall not apply to an exchange in pursuance of
a plan of reorganization within the meaning of sec-
tion 368(a)(1)(D), unless — .
(A) the corporation to [Atlas] which the [Fletch-
er] assets are transferred acquires substantially
all of the assets of the transferor of such assets
26 U.S.C. §354(b)(1)(A). The “substantially all” require-
ment is chiefly determined by focusing on the transfer of
the operating assets by the transferor, and not on the
unneeded liquid assets such as cash and accounts re-
ceivable.* In light of the facts that all of Fletcher’s assets
3. See Davant v. Commissioner, 366 F.2d 874, 886-87 (5th Cir.
1966) cert. denied, 386 U.S. 1022 (1967); James Armour, Inc. v.
Commissioner, 43 T.C. 295, 307 (1964); Commissioner v. Morgan,
288 F.2d 676, 680 (3d Cir. 1961), cert. denied, 368 U.S. 836 (1961).
- 4, Wilson v. Commissioner, 46 T.C. 334, 344 (1966); James
Armour, Inc. v. Commissioner, 43 T.C. at 307; cf. Commissioner v.
Morgan, 288 F.2d at 680.
5. See American Mfg. Co. v. Commissioner, 55 T.C. 204,
221-22 (1970) (transfer of operating assets sufficient; receivables
and cash not necessary to conduct business); Reef Corp. v. Com-
missioner, 368 F.2d 125, 131 (Sth Cir. 1966), cert. denied, 386 U.S.
9a
Appendiz A
except cash and accounts receivable went to Atlas, that
Atlas had hired all of Fletcher’s employees, that the oper-
ating assets never changed location, and were utilized
within four months to manufacture the same products,
we conclude that the “substantially all” assets require-
ment of section 354(b)(1)(A) was satisfied.
Section 354(b)(1)(B) requires, as well, that the dis-
tribution of securities in a D reorganization be “in pursu-
ance of a plan of reorganization.” The transfer was cer-
tainly a part of an overall plan. The controlling
shareholder chose to call the transaction a plan of liqui-
dation. If what resulted was a plan of reorganization, the
chosen label is not dispositive.®
We conclude, as did the Tax Court, that the transac-
tion which resulted in Fletcher’s distribution of
$482,246.82 to Schaffan met all the statutory requisites
of a D reorganization. The Schaffans urge, however, that
two nonstatutory requirements must be satisfied before
a transaction, characterized by a taxpayer as a liquida-
tion, may be treated as a reorganization: tax avoidance
motive and a continuity of business enterprise.’
The Tax Court, while expressing some skepticism
about the absence of a tax avoidance motive in structur-
1018 (1967) (transfer of operating assets without liquid cash assets:
qualified as substantially all); Moffat v. Commissioner, 363 F.2d
262, 268 (4th Cir. 1966), cert. denied, 386 U.S. 1016 (1967) (trans-
fer of key personnel and operating assets qualified as substantially
all); James Armour, Inc. v. Commissioner, 43 T.C. at 309 (transfer
of cash and receivables not necessary to qualify as substantially all);
cf. DeGroff v. Commissioner, 444 F.2d 1385, 1386 (10th Cir. 1971)
(substantially all requirement met without actual transfer where
taxpayer owned and controlled both corporations). But cf. Swanson
v. United States, 479 F.2d 539, 545-46 (9th Cir. 1973) (no satisfac-
tion of substantially all requirement due to failure to transfer essen-
tial liquid assets).
6. Wilson v. Commissioner, 46 T.C. at 345; see Grubbs v.
Commissioner, 39 T.C. 42, 49-50 (1962).
7. The continuity of business enterprise is one of two subparts
of the continuity of interest requirement. The continuity of the pro-
prietary interest held by shareholders of the transferor corporation is
imposed under section 368(a)(1)(D) and is not disputed here.
10a
Appendix A
ing the transaction, held that a finding of such a motive
was not required. The Schaffans, in advancing their tax
avoidance motive argument, rely on cases such as Greg-
ory v. Helvering, 293 U.S. 465 (1935), which held that
taxpayers cannot take advantage of the tax-free reorga-
nization provisions of the Code in the absence of a busi-
ness purpose for the transaction other than a purpose to
avoid taxes. That requirement was imposed to prevent
the resort to liquidation and reincorporation as a way of
bailing out earnings and profits without appropriate pay-
ment of taxes.
There is no disagreement among the parties that a
business purpose is required for a reorganization.® The
Schaffans contend that there was a business purpose for
liquidation as opposed to reincorporation, and that from
this business purpose for liquidation one can infer a
non-tax avoidance motive for the overall transaction.
However, the liquidation-reincorporation doctrine is
aimed at recharacterizing liquidations in light of the en-
tire transaction, notwithstanding liquidation motives.°
Thus the liquidation purpose alone, and therefore the in-
ference of a non-tax avoidance motive from it, carnot by
definition be dispositive, and certainly does not prevent
the characterization of the transaction as a D
reorganization. '°
8. See Reply Brief for Appellants-Cross Appellees at 3-4; Brief
for Commissioner as Appellee and Cross-Appetlant at 30-33.
9. See James Armour, Inc. v. Commissioner, 43 T.C. at 305;
Moffat v. Commissioner, 363 F.2d at 266; cf. Degroff v. Commis-
sioner, 444 F.2d at 1386.
10. But cf. Pridemark, Inc. v. Commissioner, 345 F.2d 35, 41
(4th Cir. 1965), overruled in different part, Of Course, Inc. v. Com-
missioner, 499 F.2d 754 (4th Cir. 1974) (holding no reorganization
because reincorporation was not to avoid taxes where liquidated
company, a dealer in prefabricated homes, had sold all its assets to
unrelated purchaser and shareholders had incorporated new corpo-
ration with same business a year later.) The holding in Pridemark
rests, in part, on the lack of continuity of business enterprise due to
the suspension of business activity. See id. at 41 & n.7.
lla
Appendiz A
The Treasury Regulations state the essence of the
requirement as:
[t]he readjustments involved in the exchanges or
distributions effected in the consummation [of a
plan of reorganization] must be undertaken for rea-
sons germane to the continuance of the business of
a corporation a party to the reorganization.
26 C.F.R. §1.368-2(g) (1979). The focus of the
nonstatutory test is not, therefore, whether there were
tax avoidance motives, but whether, objectively, there
was continuity of business rather than termination of
business. It is not significant that one party to the trans-
action was liquidated since that is a fairly common fea-
ture of a reorganization.'! What is critical is whether the
new corporation carries forward the business enterprise
of the old. The continuity of interest concept is “at the
heart of the nonrecognition provisions.”!2
Sometimes, a taxpayer will seek to establish that the
reorganization took place, thus postponing payment of
any tax. In other cases, especially where, as here, there
is a distribution of liquid assets, the taxpayer will prefer
to have the liquidation aspect separated from the rest of
the transaction so as to qualify for capital gains treat-
ment. In response, the Commissioner will seek to treat
all the events as one transaction and thus characterize it
as a reorganization in order to tax the distribution under
section 356(a) at ordinary income rates. The subjective
motivation of neither the taxpayer nor the Commissioner
is relevant. The test must be whether, objectively, the
transferee corporation, if it otherwise qualifies for reor-
ganization treatment, has a continuity of business enter-
prise with the transferor corporation. Thus we agree
11. See Lewis v. Commissioner, 176 F.2d 646. 649 (Ist Cir.
1949).
12. B. Bittker & J. Eustice, Federal Income Taxation of Corpu-
rations and Shareholders, €14.01 at 14-3 (abridged ed. 1971).
12a
Appendia A
with the Tax Court that there was no requirement that it
find a tax avoidance motive in order to classify the trans-
action as a D reorganization.
While the Schaffans urge that there was no con-
tinuity of business enterprise, the record establishes oth-
erwise. Schaffan testified:
The reason I had Fletcher Plastic’s assets go to Atlas
was, as I had explained, as a hedge so that should
anything happen—we’ve got insurance in the form
of the machinery or the molds—that we could again
start manufacturing or could start manufacturing
and not be totally without materials.
In late 1970, with the increased reliance by Atlas on for-
eign suppliers, Fletcher's business purpose was precise-
ly the same as Schaffan described the purpose for the
transfer. Fletcher was manufacturing much fewer com-
ponents for Atlas than formerly, but was standing by to
resume manufacturing if needed. After the transfer, its
machinery and equipment remained in place, ready for
use. Within four months, the machinery and equipment
was placed in operation and within a year, all of it was
utilized to make the same products as formerly. Atlas re-
tained all of Fletcher’s employees. The business enter-
prise which Atlas conducted was substantially the same
as that formerly conducted by Fletcher. Complete identi-
ty of business operations is not required.!3 The fact that
Fletcher’s former business, prior to the transfer, had
been substantially curtailed by virtue of the availability
of foreign supplies, is not dispositive. Schaffan’s busi-
ness purpose, to provide a hedge against interruption in
supplies, carried forward the continuity of enterprise
13. See, American Bronze Corp. v. Commissioner, 64 T.C.
1111, 1123-24 (1967) (continuity does not “import a requirement of
identity; the continuing business need not be the same as that con-
ducted by the transferror.”); Becher v. Commissioner, 221 F.2d
252, 253 (2d Cir. 1955).
13a
Appendia A
from Fletcher to Atlas. The Tax Court did not err in hold-
ing that the Fletcher-Atlas transaction provided the con-
tinuity of business enterprise referred to in the Treasury
Regulations. '* Since both the statutory requirements for
a D reorganization and the nonstatutory continuity of
business enterprise test are on this record satisfied, we
must affirm the Tax Court’s determination that there
was a reorganization and that section 356(a) applies to
the distribution of cash from Fletcher to Schaffan.
The Commissioner contends that while the Tax
Court correctly held that section 356(a) applies, it erred
in calculating the amount of Schaffan’s gain which
should be treated as a dividend. He relies on the inter-
pretation of section 356(a)(2) by the Fifth Circuit in’
Davant v. Commissioner, 366 F.2d 874, 889 (Sth Cir.
1966). In that case, faced with what it considered to be a
D reorganization, the court held that where there was
identity of stock interest in the two corporations, the dis-
tributing corporation and the acquiring corporation, the
earnings and profits for purposes of ‘section 356(a)(2)
would be determined by the earnings and profits of both
corporations. The Commissioner concedes that, in the
absence of such identity of interest, the reference in sec-
tion 356(a)(2) to the taxpayer’s “ratable share of the
undistributed earnings and profits of the corporation” is
a reference to the undistributed earnings and profits of
the distributing corporation. He insists, and the Davant
court held, that the statutory language should, where
stock ownership in both corporations is identical, be read
to mean “both corporations.”
Neither the Commissioner or the Davant opinion
refer us to any legislative history which would support a
rewriting of section 356(a)(2), and we see no policy rea-
sons which support our doing so. It is true that Schaffan
owns all the stock in both corporations, and that some of
the funds distributed by Fletcher came from Atlas as a
14. See 26 C.F.R. 1.368-1(b) (1979).
l4a
Appendix A
result of Atlas’ purchase of machinery, equipment and -
inventory. It is also true that because the transaction is
treated as a reorganization the transfer from Fletcher to
Atlas is not taxable. The tax-free nature of the transfer
introduces the possibility that, by overvaluing the
Fletcher assets, Schaffan could transfer earnings and
profits out of Atlas. But thereby he would necessarily in-
crease the earnings and profits of Fletcher, and thus the
amount qualifying for section 356(a)(2) treatment.
If in the future we are faced with the situation
where a single taxpayer causes a transfer of business as-
sets at inflated prices from a corporation with accumu-
lated losses to a corporation with earned surplus, thereby
attempting to accomplish capital gains treatment for
what should be ordinary income, we are confident that
section 482, 26 U.S.C. §482 (1979), which permits the
Secretary to distribute, apportion, or allocate income
among related corporations in order to prevent tax eva-
sion, will be a sufficient weapon. The rewriting of sec-
tion 356(a)(2) does not appear to be necessary. The Tax
Court has also rejected Davant.'* No other court has fol-
lowed Davant, and we decline to do so. Thus we will af-
firm the Tax Court holding that the measure of the
Schaffan’s section 356 liability is the earnings and prof-
its of Fletcher alone.
II. Atlas’ Liability for Accumulated
Earnings Tax
Sections 531 and 532 of the Internal Revenue Code
impose a tax on accumulated earnings of a corporation
formed or availed of for the purpose of avoiding the in-
come tax with respect to its shareholders, by permitting
earnings and profits to accumulate instead of being dis-
tributed as dividends. '® Section 533 of the Code provides
15. See Estate of Bell v. Commissioner, 30 T.C.M. (CCH)
1221, 1225 (1971); American Mfg. Co. v. Commissioner, 55 T.C. at
231.
16. See 26 U.S.C. §§ 531, 532 (1976).
15a
Appendia A
that accumulation of earnings and profits that are
permitted to accumulate beyond the reasonable needs of
the corporation’s business shall be determinative of a
purpose to avoid shareholder income tax, unless the cor-
poration by a preponderence of the evidence proves to
the contrary. The reasonable needs of a business include
reasonably anticipated needs.!7 An accumulation of
earnings and profits is in excess of reasonable needs if it
exceeds the amount that a prudent businessman would
consider appropriate for the present and future business
needs.'* To justify an accumulation for future business
needs, there must be an indication that the corporation
has specific, definite and feasible plans for use of such
accumulation. !9
The Commissioner determined that Atlas was liable
for accumulated earnin gs taxes for its 1969 and 1970 fis-
cal years. In those years, Atlas produced earnings and
profits considerably in excess of the amounts distributed
as dividends to Schaffan. It had experienced substantial
profits in prior years as well. Since it was not, in the
years in question, engaged in manufacturing, a large
portion of its assets was in liquid form. Atlas’ net liquid
assets — the excess of its current assets over Current
liabilities — was $2,195,840.13 at the end of 1969 and
$2,470,804.76 at the end of 1970. Its annual operating
expenses for those years were $4,788,907.43 and
$4,781,537.24, respectively. Before the Tax Court, Atlas
advanced two reasons for accumulating earnings and
profits; ordinary and extraordinary working capital
needs, and accumulation for future expansion of plant
facilities.
17. See 26 U.S.C. §537 (1976).
18. 26 C.F.R. §1.537-1(a) (1979).
19. Cheyenne Newspapers, Inc. v. Commissioner, 494 F.2d
429, 433 (10th Cir. 1974 ); Faber Cement Block Co. v. Commission-
er, 50 T.C. 317, 331 (1968); 26 C.F.R. §1.537-1(b) (1979).
l6a
Appendix A
In considering Atlas’ working capital requirements,
the Tax Court applied the so-called operating cycle test.
That test permits accumulation of current earnings to
cover the reasonably anticipated costs of operating a
business for a single operating cycle. Such a cycle is the
length of time the money is tied up in inventory and ac-
counts receivable, and thus unavailable for dividend dis-
tribution.”° The length of the cycle is determined by the
average inventory turnover period plus the average ac-
counts receivable turnover period. 'ess the average ac-
counts payable turnover period. The Tax Court deter-
mined that Atlas’ inventory turnover period was 1.33
months and the accounts receivable turnover period was
2 months, for a total sum of 3.33 months. The court
made no deduction for an accounts receivable turnover
period because it found that at least half of the inventory,
purchased from foreign suppliers, was paid for by letter
of credit — in effect prepaid. Thus it concluded that the
operating cycle was 3.33 months, or 27.75 percent of the
year. To determine Atlas’ working capital needs the
court applied that percentage to the total annual operat-
ing expenses for the years in question, thus finding
working capital needs for 1969 of $1,328,921.72. Be-
cause the working capital needs in 1970 differed only
slightly, the court allowed the same amount,
$1,328,921.72, for that year. As noted above, Atlas had
net liquid assets in each year far in excess of that
amount. The court found at the beginning of fiscal 1969
accumulated earnings and profits of $1,812,733.70, and
at the beginning of fiscal 1970 accumulated earnings
and profits of $2,181,196.70. Considering its net liquid
assets these accumulations could not be justified as
needed for working capital needs.
20. See Bardah} Int'l Co., T.C.M. (P-H) 466,182 (1966);
Bardahl Mfg. Corp., T.C.M. (P-H) £65,200 (1965); B. Bittker & J.
Eustice, Federal Income Taxation of Corporations and Sharehold-
ers $8.03 at 8-15 - 8-16 (1971 abridged ed.).
17a
Appendix A
Nor did the Tax Court accept Atlas’ explanation that
all the accumulations were justified by the need for fu-
ture plant expansions. The Atlas plant had undergone a
major expansion in 1968. While its successful history
might require future plant expansion, it had in 1969 no
specific, definite and feasible plan for such expansion.
The court concluded that in 1969 Atlas could not justify
accumulation of earnings and profits beyond its normal
working capital needs. Fer the fiscal year 1970, how-
ever, the Tax Court credited testimony that Atlas had be-
gun to plan for a future expansion and reasonably could
need to accumulate $339,000 in that year. It added that
sum to the $1,328,921.72 for the fiscal year 1970. But
even this total of $1,667,921.72 was exceeded by the
$1,812,733.70 in accumulated earnings and profits with
which the year opened.
Atias argues that the preponderence of evidence is
that its accumulations did not go beyond its reasonably
anticipated needs. The findings of the Tax Court, how-
ever, must be affirmed unless clearly erroneous.2! We
do not find them so. And to the extent that Atlas urges
that the application of the operating cycle test for deter-
mining working capital needs was legal error, we reject
that contention. The test affords a reasonable formula
for making the factual determination required by section
533.
Once it was determined that Atlas had accumulated _
earnings beyond the reasonable needs of the business,
the burden was upon Atlas to show that it had not been
availed of for the purpose of avoiding shareholder in-
come tax. Noting that Atlas’ dividends were small com-
pared to its earnings, that Schaffan’s salary was not sub-
stantial, and that his marginal tax rate was higher than
the corporation’s, the Tax Court held that this burden
had not been carried. Here, again, the Tax Court's find-
ings of fact are not clearly erroneous.
21. Commissioner v. Duberstein, 363 U.S. 278, 291 (1960);
Nemours Corp. v. Commissioner, 325 F.2d 559, 560 (3d Cir. 1963).
18a
Appendix A
III. Atlas’ Transferee Liability
For Fletcher’s Tax Obligation
The Commissioner determined that Fletcher also
accumulated earnings beyond the reasonable needs of
its business, and imposed an accumulated earnings tax
for its fiscal years ending November 30, 1968 and 1969.
This Fletcher liability is not disputed. A deficiency no-
tice was mailed to Atlas as Fletcher’s successor. The Tax
Court held that the tax was collectible from Atlas, as
transferee, by virtue of section 6901(a)(1)(A).2? That
section permits collection from a transferee if under the
governing state law the transferee would be liable for the
transferor’s debts. The state law in issue is that of New
Jersey, and the Tax Court concluded that New Jersey
would treat the Fletcher-Atlas transaction as a de facto
merger, and a continuation of Fletcher’s business.
Normally, a corporation that purchases all of the as-
sets of another corporation is not liable for the debts of
the transferor.?* However, the New Jersey courts have
formulated exceptions to the rule in the context of per-
sonal injury/products liability and minority appraisal
suits. The leading New Jersey case is McKee v.
Harris-Seybold Co., 109 N.J. Super. 555, 264 A.2d 98
(Super. Ct. Law Div. 1970), affd per curiam, 118 N.J.
Super. 480, 288 A.2d 585 (Super. Ct. App. Div. 1972).
The McKee court noted five exceptions, two of which are
relevant here: (1) “the transaction amounts to a consoli-
dation or merger of the seller and purchaser; (2) the pur-
chasing corporation is merely a continuation of the sell-
ing corporation.” 109 N.J. Super. at 561, 264 A.2d at
101.
De facto mergers have been found where a sale is
really a merger; one corporation absorbing the other, the
absorbed corporation going out of existence and losing
22. 26 U.S.C. §6901(a)(1)(A) (1976).
23. 15 Fletcher Cyc. Corp. 17122 at 188 (perm. ed. 1973).
19a
Appendix A
its identity to the absorbing corporation that remains. In
de facto situations, the factors considered have included:
(1) continuation of the same sharehoider control — par-
ticularly in the instance of a sole shareholder, (2) inten-
tion to dissolve the selling company, (3) retention of ex-
ecutive and operating personnel of the vendor by the
transferee, (4) transfer of assets and shares, (5) assump-
tion of vendor’s liabilities, (6) a “pooling of interests,”24
Most of these elements are present in the case sub
judice. Moreover, every factor is not essential for apply-
ing the doctrine. Good v. Lackawanna Leather Co., 96
N.J. Super. 439, 452, 233 A.2d 201, 208 (Super. Ct. Ch.
Div. 1967). However, in Good, the court found that be-
cause most of the elements were missing, most particu-
larly, including the transfer of assets in exchange for
shares, the de facto doctrine did not apply. See id.
In Wilson v. Fare Well Corp., 140 N.J. Super. 476,
356 A.2d 458, (Super. Ct. Law Div. 1976), the court
found the de facto doctrine applicable because there was
continuity of management, personnel, physical location,
assets, general business operations, shareholders, and
the seller had ceased operations and the transferee had
assumed the continuation of the business. The court
while recognizing the McKee factors, adopted the “mod-
ern, fair-minded broad approach” to the doctrine. 140
N.J. Super. at 493, 356 A.2d at 468. 7
In Shannon v. Samuel Langston Co., 379 F. Supp.
797 (W.D. Mich. 1974), the court found a de facto
merger under New Jersey law where there was a con-
tinuation of the shareholders and business enterprise
and the transferor had liquidated.
As is illustrated by the de facto merger cases, that
exception is interrelated to the second exception for con-
24. McKee v. Harris-Seybold Co., 109 N.J. Super. at 564; 264
A.2d at 103; Applestein v. United Board & Carton Corp., 60 N.J. Su-
per. 333, 348, 159 A.2d 146, 154 (Super. Ct. Ch. Div.), aff'd per
curiam, 33 N.J..72, 161 A.2d 474 (1960).
20a
Appendia A
tinuity. In McKee, there was no evidence of continuity of
management or stockholder investment and the trans-
feror did not liquidate until two years after the sale, al-
though the purchaser presumably did continue the
manufacturing operations. “For liability to attach, the
purchasing corporation must represent merely a ‘new
hat’ for the seller.” McKee v. Harris-Seybold Co., 109
N.J. Super. at 570, 264 A.2d at 106. Certainly, in the
case at bar there is continuity of shareholder investment
and Fletcher was liquidated almost immediately. How-
ever, even in a case where the transferor corporation liq-
uidated soon after the sale, this was held not to be
dispositive. Menacho v. Adamson United Co., 420 F.
Supp. 128 (D.N.J. 1976) (no de factu merger). Menacho
is distinguishable from the case at bar because the
Menacho court found that there was no continuity of
management or control. 420 F. Supp. 134-35.
In Jackson v. Diamond T. Trucking Co., 100 N.J.
Super. 186, 241 A.2d 471 (Super. Ct. Law Div. 1968),
the court held a transferee corporation liable for the
transferor under the continuation exception. Although
the court noted that the factual conclusion that the
transferee corporation was a continuation of the trans-
feror did not necessarily lead to imposing liability be-
cause a weighing of policy factors was required. The
courts that have found a de facto merger or a continu-
ation of the enterprise have involved public policy con-
siderations which favor compensating tort victims or ap-
praisal rights to minority shareholders.2° We do not
believe that the New Jersey courts would regard the fa-
vored public policy of the collection of the federal rev-
enue any less highly.
25. See Knapp v. North American Rockwell Corp., 506 F.2d
361, 367 (3d Cir. 1974), cert. denied, 421 U.S. 965 (1975) (decided
under Pa. law).
2la
Appendix A
Under the case law discussed, continuity is the ba-
Sis and test for both the de facto and continuity doc-
trines. Although, there was no stock transfer here, and
only cash was involved, there was Clearly a continuation
of stockholder interest. The stock exchange element of
the de facto doctrine appears to be aimed at measuring
continuity of stockholder interest. Moreover, it was not
unreasonable for the Tax Court to find adequate con-
tinuity of the business activity by Atlas for the reasons it
found such continuity under section 368, 26 U.S.C.
§368 (1976). Atlas purchased all the operating machin-
ery and inventory, utilized the machinery for the same
purposes, retained it in the same location, retained the
Same employees, and the transferor company was liqui-
dated almost immediately. Thus we hold that the Tax
Court did not err in holding that under New Jersey law
Atlas was liable for Fletcher’s tax obligations, and that
those obligations could be collected pursuant to section
6901(a)(1)(A),2°
IV.’Conclusion
The decision of the Tax Court will be affierned in all
respects.
A True Copy:
Teste:
Clerk of the United States Cou rt of Appeals
for the Third Circuit
26. 26 U.S.C. §6901(a)(1)(A) (1976),
22a
APPENDIX B
Order Amending Opinion
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 78-2631
ATLAS TOOL CO., INC., Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7633-74)
ATLAS TOOL CO., INC., Successor to
Fletcher Plastics, Inc.,
Petitioner
Uv.
COMMISSIONER OF INTERNAL REVENUE, —
Respondent
(Tax Court Docket No. 7634-74)
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Petitioners
VU.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7635-74)
ATLAS TOOL CO., INC., ATLAS TOOL CO., INC.,
Successor to Fletcher Plastics, Inc.
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Appellants
23a
Appendix B
No. 78-2632
ATLAS TOOL CO., INC., Petitioner
U.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7633-74)
ATLAS TOOL CO., INC., Successor
to Fletcher Plastics, Inc., Petitioner
U.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7634-74)
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
(Tax Court Docket No. 7635-74)
COMMISSIONER OF INTERNAL REVENUE,
Appellant
ON APPEAL FROM THE UNITED STATES TAX COURT
Argued: October 15, 1979
Before: GIBBONS and HIGGINBOTHAM, Circuit Judges
and WEINER, District Judge
(Opinion Filed January 28, 1980)
24a
Appendix B
ORDER AMENDING OPINION
The slip opinion in the above matter is hereby
amended as follows:
Page 13, First Line of Second Full Paragraph
The word “nor” is substituted for the word “or.”
Page 19
Line 14 — The word “most” is deleted.
Line 15 — The word “including” and the comma
preceding it are deleted.
Page 20
Line 17 — The word “at” is inserted before 134-35.
First Full Paragraph, Lines 4-5 — The word “Al-
though” is deleted, and “The” substituted for “the.”
JOHN J. GIBBONS
Circuit Judge
‘Dated: January 31, 1980
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
25a
APPENDIX C
Opinion of the United States Tax Court
Filed: April 27, 1978
70 'T.C, No. 11
Unitrep States Tax Court
»™
ae
Atias Toot Co., Inc., et al.,)
Petitioners,
Ve
CoMMISSIONER OF INTERNAL REVENUE,
Respondent.
Docket Nos. 7633-74,
7634-74,
7635-74.
a
Corporation A and corporation B were each wholly
owned by 8. Corporation A was the principal purchaser
of corporation B’s production. In connection with a
plan to terminate corporation B’s activities and rely on
foreign suppliers, corporation A acquired for cash cor-
poration B’s operating assets. Corporation B then dis-
tributed all of its remaining assets to S and dissolved.
‘Cases of the following petitioners are consolidated herewith:
Atlas Tool Co., Inc., Successor to Fletcher Plastics, Inc., docket
No. 7634-74; and Stephan Schaffan and Mildred Schaffan, docket
No. 7635-74,
26a
Appendiz C
Corporation B’s operating assets were acquired to ensure
corporation A’s supply of goods, but corporation A hoped
not to have to use them. No active use of the assets was
made for approximately 3 months. However, after prob-
lems developed with the foreign suppliers, the assets were
gradually placed into service in the same manner as they
had been employed by corporation B.
Held: The steps taken by the parties, including the
liquidation of corporation B, were integral steps in a plan
of reorganization deseribed in sec. 368(a)(1)(D), I.R.C.
1954, and the distribution to S is taxed under see. 356(a),
LR.C. 1954.
Held, further: The distribution has the effect of a divi-
dend within the meaning of sec. 356(a) (2), I.R.C. 1954, and
S’s gain is to be treated as a dividend to the extent of
corporation B’s earnings and profits.
Held, further: As transferee of corporation B’s assets,
corporation A is liable for the tax liabilities of corpora-
tion B because under New Jersey law there was a de facto
merger of the two corporations and because under New
Jersey law corporation A was the mere continuation of
corporation B.
Held, further: Corporation A is liable for accumulated
earnings taxes for its taxable years in issue.
John J. O'Toole and Edwin F radkin, for the petitioners.
Marwin A. Batt, for the respondent.
Scorr, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes in the following
amounts:
27a
Appendix C
Docket Taxable Year
Petitioner No. I’nded Deficiency
Atlas Tool Co., Inc. 7633-74 June 30, 1969 $147,103.59
June 30, 1970 98,933.78
Atlas Tool Co., Ine., 7634-74 Nov. 30, 1968 14,985.42
Successor to Nov. 30, 1969 22,161.39
Fletcher Plasties, Nov. 30, 1970 1,238.66
Ine.
Stephan Schaffan 7635-74 Dee. 31,1970 232,121.36
and Mildred
Schaffan
After concessions by the parties, the following issues
remain for our consideration:
(1) Whether a corporate distribution received by peti-
tioner Stephan Schaffan in 1970 was a distribution in
complete liquidation of Fletcher Plastics, Inc., treated un-
cer section 331, I.R.C. 1954,? or a distribution of money
in pursuance of a plan of reorganization involving Flet-
cher Plastics, Inc. and Atlas Tool Co., Ine., treated in
whole or in part as a dividend under section 306(a) :
(2) in the latter case, whether the amount of a dividend
under section 356(a) is measured by the earnings and
profits only of Fletcher Plastics, Ine. or by those of Atlas
Tool Co., Ine. as well;
* All statutory references are to the Internal Revenue Code of
1954, as amended.
28a
Appendix C
(3) whether Atlas Tool Co., Ine. is liable for the income
tax deficiencies of Fletcher Plastics, Ine. at issue in this
case; and
(4) whether Atlas Tool Co., Inc. was formed or availed
of for the purpose of avoiding the income tax with re-
spect to its shareholder, Stephan Schaffan, by permitting
its earnings and profits to accumulate instead of being
distributed, within the meaning of section 532.
Finpines or Facr
Some of the facts have been stipulated and are found
accordingly.
Petitioners Stephan Schaffan and Mildred Schaffan filed
a joint individual Federal income tax return for calendar
year 1970, during which year they were husband and wife.
At the time of filing their petition in this case, they each
resided in New Jersey. Petitioner Atlas Tool Co., Ine.
(hereinafter Atlas) filed corporate Federal income tax re-
turns for its fiscal years ending June 30, 1969, and June
30, 1970. Fletcher Plastics, Ine. (hereinafter Fletcher)
filed corporate Federal income tax returns for its fiseal
years ending November 30, 1968, November 30, 1969, and
November 30, 1970. At the time of filing its petitions in
this case, Atlas maintained its principal place of business
in Hillside, New Jersey.
Stephan Schaffan’s father organized the Atlas Tool
Company as a sole proprietorship in 1924. The proprie-
torship manufactured tools, dies, jigs and fixtures for
metal forming, blanking, and stamping and produced cer-
tain specialized equipment. Stephan Schaffan began work-
ing in the business in 1931. He became a partner in 1945.
29a
Appendix C
Beginning in 1945, the partnership became involved in
manufacture and sales in the model railroad industry. It
simultaneously phased out its manufacture of tools and
dies for unrelated parties. After 1949 and to date, the
company’s efforts have been devoted almost exclusively
to the hobby industry, including model railroads and
model motoring.
After his father’s death in 1948, Stephan Schaffan op-
erated the business as a proprietorship until it was in-
corporated in 1949 as Atlas Tool Co., Ine. Stephan Schaf-
fan has always been president and principal stockholder
of Atlas. During the years in issue, he was the sole stock-
holder.
Prior to 1960, Atlas conducted design, manufacturing,
assembly and sales functions as an integrated operation.
It manufactured principally track, switches and access-
ories for model railroads. In 1960, Fletcher was incor-
porated by Stephan Schaffan, who became its president
and sole stockholder. Atlas’ plastic injection molding ma-
chines were transferred to Fletcher, and Fletcher then
performed molding and production of subassemblies for
Atlas. Thereafter, Atlas conducted only design, assembly
and sales functions. Fletcher made only a few, isolated
sales of goods to buyers other than Atlas, Atlas, how-
ever, purchased inventory from unrelated domestie and
foreign manufacturers for inclusion in its sales line.
Fletcher’s operations, its machinery, equipment, em-
ployees, books and records, were located at 378 Florence
Avenue, Hillside, New Jersey, in a building owned by
West Shelton Realty Co., a corporation owned solely by
Stephan Schaffan. Fletcher’s machinery oceupied the first
floor of the building. This building also served as the main
30a
Appendia C
plant and offices of Atlas, which also leased its space from
the realty company.
The operations of Atlas were housed in four build-
ings during the years in issue. The original building,
413 Florence Avenue, was acquired in 1948 and expanded
twice between 1950 and 1952. The 378 Florence Ave-
nue building was constructed in 1951 and expanded in
1959 and 1968. Two other buildings were constructed in
1961 and 1964, Stephan Schaffan owned the 413 Florence
Avenue property personally. Aside from 378 and 413 Flor-
ence Avenue, the other buildings were owned by Atlas.
A fifth building was constructed by Atlas of land ac-
quired from Stephan Schaffan in 1972. The need for ad-
ditional space had become apparent about 1969, and the
active planning for the building was begun in 1973. Con-
struction was commenced in 1974, and Atlas received a
certificate for occupancy on May 28, 1975. The total cost
of the building, including mechanical equipment it con-
tained, was $783,934. At least $533,412 of this amount
was paid prior to March 15, 1975.
Atlas began purchasing components from foreign sources
in 1959. It increased the amount and variety of these
imported items throughout the 1960’s purchasing from
companies in Germany, Italy, Yugoslavia, Austria, Japan
and Hong Kong. It found that these imports were cheaper
than domestically manufactured goods and that their
quality was good. Atlas experienced only occasional prob-
lems with the quality and shipping arrangements of its
imports before 1970. Atlas became increasingly dependent
on these imports. During its fiseal years ending June 30
in 1968, 1969 and 1970, imports were approximately 46.6
percent, 45 percent and 47 percent, respectively, of Atlas’
total purchases.
3la
Appendiaz C
During the years in issue, Atlas normally employed
irrevocable letters of credit to pay for its imports. It
also used checks and sight drafts for small orders. The
letters of credit were obtained through the First National
State Bank of New Jersey in the amount of a purchase
order and forwarded to the foreign manufacturer. The
manufacturer was not required to begin production on
the order until receipt of the letter of credit, but in fact
Atlas’ regular suppliers usually had already begun pro-
duction when the letter was issued. The manufacturer was
entitled to payment on the order, according to the terms
of the letter of credit, upon placing the goods with the
carrier. At that point, Atlas’ account was charged for
the payment and a debit notice was mailed to it. Atlas
then received the goods in due course from the carrier,
usually within 2 to 3 weeks. Until the manufacturer re-
ceived payment, the letter of credit represented only a
contingent liability. Payment was due only if and when
the goods were shipped. However, the letter of credit
served as security for the manufacturer while the order
was prepared.
Dozens of individual letters of credit were outstanding
over the course of any of the years in issue. They could
be extended, and many were extended during those years.
During the calendar years 1968, 1969 and 1970, the total
amounts of the letters of credit issued on behalf of Atlas
were $991,250, $1,497,700 and $385,640, respectively. Fewer
letters of credit were issued in 1970 because certain Euro-
pean suppliers were beginning to extend eredit to Atlas
and were shipping goods without the benefit of letters of
credit. The total amount of letters of credit outstanding
at any one time during the fiscal years ending June 30,
1968, and June 30, 1969, was between $500,000 and $600,000.
32a
Appendix C
During 1970, 1971 and 1972, Atlas had lines of credit at
First National State Bank of Newark in the amounts of
$650,000, $650,000 and $240,000, respectively. Atlas had a
line of credit with that bank in the other years in issue as
well. However, Atlas never borrowed on its line of credit
during any of these years. Atlas paid all of its letters
of credit and its other payables currently with funds on
hand. Purchasers from Atlas usually paid for their pur-
chases within approximately 30 days of shipment.
The assets and liabilities of Atlas for its fiscal years
ending in 1964 through 1974, taken from its balance sheets,
are summarized below. Also noted as the dividends it
paid during the year and its retained earnings as of the
end of each year.
Atlas maintained its cash in checking and savings ac-
counts and in certificates of deposit.
The assets and liabilities of Fletcher for its fiscal years
ending in 1962 through 1969, taken from its balance sheets,
are on Table 2, p. 34a. Also noted are the dividends it
paid during the year and its retained earnings as of the
end of each year.
33a
Appendix C
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37a
Appendix C
On his joint Federal income tax returns for 1968, 1969
and 1970 and on his return for 1971, Stephan Schaffan
reported the following adjusted gross income and total
income tax liabilities:
Adjusted Income Tax
Year Gross Income Inability
1968 $152,336 $ 81,611
1969 160,826 90,107
1970 372,217 210,271
1971 184,466 109,760
After prior consideration, the decision was made in
1969 that the manufacturing operations carried on by
Fletcher were no longer essential since the components
it produced were available from foreign sources. Pur-
suant to this decision the following actions were planned
and executed:
(1) An appraisal of all of Fletcher’s equipment and
machinery was obtained from an unrelated appraisal com-
pany. The appraisal report, dated June 1, 1970, and
forwarded under a cover letter dated August 3, 1970, econ-
cluded that the fair market value of the described equip-
ment and machinery was $100,250.
(2) On October 14, 1970, meetings were held of the
directors and shareholders of Fletcher Plasties, Ine. which
authorized dissolution of the corporation and liquidation
38a
Appendix C
and distribution of its assets expressly pursuant to sec-
tion 337 of the Internal Revenue Code of 1954.°
(3) On October 15, 1970, Fletcher’s attorneys filed with
the District Director of Internal Revenue, Newark, New
Jersey, a Form 966, “Corporate Dissolution or Liquida-
tion,” reciting that the liquidation was to be “complete”
and performed under section 337.
(4) Also in October of 1970, the corporation applied for
a tax clearance certificate from the State of New Jersey
in order to commence dissolution.
(5) On November 5, 1970, Fletcher transferred to Atlas
all of its equipment and machinery, as described in the
appraisal report, and received a check from Atlas for
$100,250. Fletcher also transferred its inventory to Atlas
for $14,600, its cost to Fletcher. The only accounts receiv-
able by Fletcher at the time were from Atlas, which paid
them in full.
(6) On November 19, 1970, Stephan Schaffan received a
eash distribution from Fletcher which represented all of
its remaining assets.
3 The minutes of the special meeting of the stockohlders recited,
in part:
“Such transfer is to be subject to any and all outstanding
liens and claims of every kind, nature and description and
that said transfer of the assets and property shall be in ex-
change for the complete cancellation or redemption of all of
the issued and outstanding stock of the corporation held by
each stockholder which shall be delivered and transferred to
the corporation.”
39a
Appendix C
(7) Final tax returns were filed with both State and
Federal authorities.
(8) On June 11, 1971, a Certificate of Dissolution was
filed for Fletcher by Stephan Schaffan with the New Jer-
sey Secretary of State.
No written plan of liquidation existed other than the
documents evidencing these actions.
After these actions the machinery and equipment trans-
ferred to Atlas remained in place at 378 Florence Avenue.
It was idle from approximately November 5, 1970, until
the end of February, 1971. Fletcher’s employees remained
in the employ of Atlas, which used them initially in its
packing and shipping departments. It was Atlas’ policy
not to fire personnel other than for cause, since its attri-
tion rate was high.
Atlas’ sales were seasonal. The heaviest sales volume
occurred from September through February with a high
concentration of sales before Christmas. To meet this sea-
sonal demand, Atlas stockpiled its inventory during the
periods preceding highest demand. Fletcher’s manufactur-
ing equipment was operated continuously throughout the
year, although its operations were slower in December
and January. Normally, after Atlas was sufficiently sup-
plied for the current sales season, Fletcher’s operations
contributed to stockpiles for the following year.
In 1970 in anticipation of terminating Fletcher’s manu-
facturing activities, additional orders were placed by At-
las with foreign suppliers for items previously supplied
by Fletcher. Stockpiles of these items were deemed suf-
ficient to last through the peak sales season.
40a
Appendix C
In December of 1970, problems with the quality of for-
eign supplies began appearing. Initially, Atlas received a
shipment of railroad track that was twisted, and Mr.
Schaffan flew to Europe in December or the following
January to help remedy the problem. He was not success-
ful, and defective track continued to be shipped. Further-
more, other defective material was received in the 3 or 4
months following November 5, 1970, and delays in ship-
ments occurred. Some of the defective material was re-
turned, and some was repaired by Atlas.
About the end of February, 1971, Atlas became worried
about maintaining its inventory through the next season.
At that time it began manufacturing components for its
product line with two or three of the 29 injection mold-
ing machines acquired from Fletcher on November 5, 1970.
During 1971, Atlas continued to experience inadequate
deliveries and quality from the foreign suppliers, and ad-
ditional machines were placed in service. By the fall of
1971, all of the manufacturing equipment and machinery
acquired from Fletcher had been placed in operation. At
the time of the hearing in this case, Atlas was still manu-
facturing components for its product lines. Some of the
machines aequired from Fletcher were still in use, and
new machines had been purchased and updated.
On their income tax return for 1970, Stephan and Mil-
dred Schaffan reported a capital gain of $390,000 on the
eash distribution to Stephan Schaffan from Fletcher. They
reported a gross sales price of $400,000 and an adjusted
basis of $10,000. In his notice of deficiency to these peti-
tioners, respondent made the following determination:
The alleged sale of the operating assets of Fletcher
Plasties, Inc. to Atlas Tool Co., both commonly
4la
Appendix C
owned by Stephan Schaffan, and a distribution of
assets of Fletcher Plastics, Inc. to Stephan Schaf-
fan, constituted a reorganization under Code Sec-
tion 368(a)(1)(D) and a dividend distribution un-
der Code Section 356(a). Further no “complete
liquidation” of Fletcher Plastics, Inc. occurred here
and hence Section 337 of the Code does not apply.
Accordingly, the distribution of $482,246.86 is tax-
able as an ordinary dividend.
Petitioner Atlas Tool Co., Ine. has petitioned from two
notices mailed to it by respondent. In the first, addressed
to Atlas Tool Co., Ine., respondent “determined that earn-
ings and profits [had] been accumulated beyond the rea-
sonable needs of the business” and imposed an accumu-
lated earnings tax for Atlas’ fiscal years ending June 30,
1969, and June 30, 1970, in the amounts of $131,762.47 and
$87,477.54, respectively. The second notice was addressed
to “Atlas Tool Co., Ine., Successor to Fletcher Plastics,
Ine.” and was labeled a “Notice of Deficiency.” This no-
tice made the following determination:
It has been determined that Atlas Tool Co., Ine. is
the successor to Fletcher Plastics, Ine. because At-
las Tool Co. acquired the business of Fletcher Plas-
ties, Ine. within the ambit of section 368(a)(1)(D)
of the Internal Revenue Code.
It has been determined that the earnings and profits
of Fletcher Plastics, Ine. have accumulated beyond
the reasonable needs of the business in each of the
taxable years ended November 30, 1968 and Novem-
ber 30, 1969. Therefore, the tax provided by sec-
tion 531 of the Internal Revenue Code has been im-
posed in each taxable year. * * *
42a
Appendia C
The amounts of accumulated earnings tax imposed were
$13,728.82 and $20,147, respectively.
In prior action by this Court, we held that a valid,
timely petition had been filed on behalf of Atlas in docket
No. 7634-74, although the original petition had been ecap-
tioned “Fletcher Plastics, Inc., Stephan Schaffan, Trans-
feree,” and we allowed Atlas to amend its pleadings to
conform with the notice it received. Fletcher Plastics, Inc.,
Stephan Schaffan, Transferee v. Commissioner, 64 T.C. 35
(1975). Subsequently, petitioner filed a motion to dismiss
or in the alternative to require respondent to plead trans-
feree liability. By order dated January 21, 1977, we de-
nied the motion to dismiss, but allowed respondent to file
an amended answer making proper allegation of trans-
feree liability.
OPINION
Issue 1. Distribution to Stephan Schaffan
Stephan Schaffan owned all of the stock of two corpora-
tions, Atlas and Fletcher. In 1970, Fletcher transferred
all of its operating assets and inventory to Atlas and re-
ceived cash in return. Fletcher then distributed to Schaf-
fan all of its remaining assets, consisting only of cash.
Subsequently in 1971, Fletcher was dissolved under state
law. Petitioners assert that these transactions should be
characterized according to the forms they took, a sale by
Fletcher to Atlas on which gain is not recognized under
section 337 and a distribution in complete liquidation of
Fletcher that was entitled to treatment as full payment
in exchange of Stephan Schaffan’s stock under section 331.
Respondent, on the other hand, has determined that no
complete liquidation of Fletcher occurred, that the trans-
43a
Appendix C
actions in fact constitute a reorganization of Fletcher and
Atlas described in section 368(a)(1)(D),* and that the dis-
tribution was wholly a taxable dividend to Stephan Schaf-
fan under section 356(a).
Fact patterns similar to that of the instant ease have
been the subject of frequent litigation. It is well estab-
lished that in a proper case a transaction styled as a cor-
porate sale of assets and liquidation may be recharacter-
ized for Federal tax purposes as a reorganization and
may lead to quite different tax results. See, e.g., DeGroff
v. Commissioner, 54 T.C. 59 (1970), affd. per curiam 444
F.2d 1385 (10th Cir. 1971); Wilson v. Commissioner, 46
T.C. 334 (1966). ,
The facts of this case fall within the statutory defini-
tion of a reorganization described in section 368(a) (1)
(D).” There was a transfer by Fletcher of a part of its
* by amendment to his answers in docket Nos. 7634-74 and 7635-
74, respondent raised for the first time an allegation that the steps
in which Fletcher and Atlas engaged also constituted a reorganiza-
tion described in sec. 368(a)(1)(F). Respondent expressly aban-
doned this position on brief, relying on his allegation of a “D”
reorganization.
®Sec. 368(a). Reorganization.—
(1) In General—For purposes of parts I and 1I and this part, the
term “reorganziation” means—
* KK
(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 trans-
fer), or any combination thereof, is in control of the corpora-
tion to which the assets are transferred; but only if, in pur-
suance of the plan, stock or securities of the corporation to
which the assets are transferred are distributed in a trans-
action which qualifies under section 354, 355, or 356;
44a
Appendiz C
assets to Atlas, and immediately after the transfer, the
shareholder of the transferor was in control of the cor-
poration to which the assets were transferred. Although
no stock or securities were actually distributed by Atlas
as a part of the transaction, we have repeatedly held that,
when the stock ownership of transferor and transferee is
identical, the actual distribution would be a mere for-
mality and the statute may be satisfied without it. See
American Manufacturing Co. v. Commissioner, 55 T.C. 204,
221 (1970); James Armour, Inc. v. Commissioner, 43 T.C.
295, 307 (1964).
Furthermore, the distribution, had it been made, would
have qualified under section 354.6 The transferee corpo-
6 Sec. 354. EXCHANGES oF STOCK AND SECUITIES IN CERTAIN
REORGANIZATIONS.
(a) General Rule.—
(1) In General.—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.
* * *
(b) Exception.—
(1) In General—Subsection (a) shall not apply to an
exchange in pursuance of a plan of reorganization within
the meaning of section 368(a)(1)(D), unless—
(A) the corporation to which the assets are transferred
acquires substantially all of the assets of the transferor
of such assets; and
(B) the stock, securities, and other properties received
by such transferor, as well as the other properties of such
transferor, are distributed in pursuance of the plan of re-
organization.
45a,
Appendix C
ration must acquire “substantially all of the assets of the
transferor” under section 354(b)(1)(A), but it is sufficient
for this requirement that all assets necessary or appro-
priate to the conduct of the transferor’s business be trans-
ferred. Wilson v. Commissioner, supra at 345; Moffat v.
Commissioner, 42 T.C, 558, 578 (1964). Here, all assets of
Fletcher other than cash were transferred to Atlas, and
this falls well within the statute. See Wilson v. Com-
missioner, supra at 346. All assets remaining in Fletcher
after the transfer were distributed to its shareholder,
satisfying section 354(b)(1)(B). Finally, these steps were
taken pursuant to a plan of reorganization. Each step
taken in connection with Fletcher’s transfer of assets to
Atlas and its distribution of residual assets to Stephan
Schaffan were part of an overall plan by the management
and stockholders of Atlas and Fletcher to achieve an end
result that we find to be the reorgnization of the two cor-
porations. The labels attached to the transaction by
petitioners do not alter the nature of the plan, and no
formal written document is necessary. See Wilson vy.
Commisisoner, supra at 345; Lesser v. Commissioner, 26
T.C. 306, 311-12 (1956).
In spite of the satisfaction of the statutory require-
ments petitioners have asserted two grounds for finding
on these facts that no reorganization occurred. First,
they contend that there was no tax avoidance motive for
the steps taken by Fletcher and, therefore, that the form
in which the steps were cast should control their tax
effects. Second, petitioners contend “that there was no
continuation of Fletcher’s business enterprise in Atlas,”
which continuation they deem necessary for treatment
as a reorgnization.
46a,
Appendix C
Contrary to petitioners’ first contention, there is no
requirement that tax avoidance be found to be the motive
of a transaction styled as a liquidation before that trans-
action can be properly recharacterized as a reorganization.
Although tax avoidance is often the motivation where steps
are taken and labels are assigned which deny the true
nature of a transaction, treatment of a transaction as a
reorganization, in accordance with the substance of the
transaction, does not depend upon such a motive. See
American Manufacturing Co, v. Commissioner, supra;
Wilson v. Commissioner, supra; Lesser v. Commissioner,
supra; cf. Lewis v. Commissioner, 10 T.C. 1080, 1086-88
(1948), affd. 176 F.2d 646 (1st Cir. 1949).7 Here, all the
steps relating to the transfer of Fletcher’s operating
assets to Atlas and the distribution of cash to Stephan
Schaffan were taken as preconceived steps in a single
plan of action. The intended and actual result of the
plan was the realignment of assets among the two cor-
porations and their stockholder. The tax effects of the
realignment must be determined by viewing the transac-
tions together rather than as unrelated steps, regardless
of petitioners’ motives. See James Armour, Inc. v. Com-
missioner, supra at 305. Therefore, the form in which any
single step was cast cannot determine the tax consequences
of the complete transaction.
Furthermore, in our view, petitioners’ denial of any tax
avoidance motives cannot be fully accepted as fact. It is
true that the decisions to interrupt Fletcher’s activities
indefinitely, to rely on imported goods and to retain Flet-
cher’s operating assets were made for reasons solely re-
7 See also Estate of Bell v. Commissioner, T.C. Memo. 1971-285.
But see Pridemark, Inc. v. Commissioner, 345 F.2d 35, 41 (4th Cir.
1965), affg. in part and revg. in part 42 T.C. 510 (1964).
47a
Appendix C
lated to the businesses conducted by the two corporations.
The steps taken to carry out these decisions were not dic-
tated by these businesses, however, but by the personal
concerns of Stephan Schaffan. It is our view that, having
decided that his corporations would take certain actions
for business reasons, Stephan Schaffan attempted to seize
on the opportunity to extract cash from his corporations
at favorable tax rates by carefully selecting the form of
the transaction. We do not Suggest that it is improper
for a taxpayer to seek to reduce or avoid taxes in this
manner, short of evasion. However, when the net result
of the steps so taken is that of a reorganization deseribed
in section 368, a taxpayer cannot avoid the reorganiza-
tion provisions simply by labeling his steps otherwise.
Petitioners’ second contention relates to the nonstatu-
tory requirements of reorganizations. Mere mechanical
satisfaction of the statutory reorganization provisions
alone will not result in reorganization treatment, Section
1.368-1, Income Tax Regs., provides in part:
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 prop-
erty under modified corporate forms. Requisite to
a reorganization under the Code are a continuity of
the business enterprise under the modified corporate
form, and (except as provided in scetion 368 (a) (1)
(D)) a continuity of interest therein on the part of
those persons who, directly or indirectly, were the
owners of the enterprise prior to the reorganiza-
tion. * * * [See. 1.368-1(b), Income Tax Regs.]}
48a
Appendix C
A plan of reorganization must contemplate the bona
fide execution of one of the transactions specifically
described as a reorganization in section 368(a) and
for the bona fide consummation of each of the requi-
site acts under which nonrecognition of gain is
claimed. Such transaction and such acts must be an
ordinary and necessary incident of the conduct of
the enterprise and must provide for a continuation
of the enterprise. A scheme, which involves an
abrupt departure from normal reorganization pro-
cedure in connection with a transaction on which
the imposition of tax is imminent, such as a mere
device that puts on the form of a corporate reor-
ganization as a disguise for concealing its real char-
acter, and the object and accomplishment of which
is the consummation of a preconceived plan having
no business or corporate purpose, is not a plan
of reorgnization. [Sec. 1.368-1(¢), Income Tax
Regs. ]
Moreover, the transaction, or series of transactions,
embraced in a plan of reorganization must not only
come within the specific language of section 368(a),
but the readjustments involved in the exchanges or
distributions effected in the consummation thereof
must be undertaken for reasons germane to the con-
tinuance of the business of a corporation a party
to the reorganization. Section 368(a) contemplates
genuine corporation reorganizations which are de-
signed to effect a readjustment of continuing inter-
ests under modified corporate forms. [See. 1.368-2
(g), Income Tax Regs. ]
The nonstatutory requirements are usually formulated as
(1) continuity of the proprietary interest held by the
49a
Appendix C
shareholders of the transferor corporation, (2) continuity
of the business enterprise, and (3) a business purpose for
the reorganization. Norman Scott, Inc, vy. Commissioner,
48 T.C. 598, 603 (1967). See also American Bronze Cor-
poration v. Commissioner, 64 T.C. 1111, 1123 (1975).§
Petitioners have framed their argument more narrowly
than these formulations. The thrust of their argument is
that a continuation of Fletcher’s specific business activi-
ties by Atlas must occur for there to be a reorganization
and that this continuation must be intended and uninter-
rupted. Petitioners assert that none of these conditions
were satisfied in this case.
In our view, neither the business purpose requirement
nor the continuity of business enterprise requirement en-
compasses petitioners’ asserted test. Although the busi-
ness purpose of a reorganization may be more readily dis-
cerned if the transferor’s business is continued,® peti-
tioners themselves have asserted that there were substan-
tial business purposes for the dissolution of Fletcher and
transfer of its assets to Atlas and that there were no tax
avoidance motives for these actions. Continuation of the
transferor’s business certainly is not a prerequisite to every
imaginable business purpose for a reorganization. The
purpose of petitioners to retain the assets in corporate
Sra}
|
“As Stephan Schaffan was the sole sharcholder of Fletcher and
Atlas, there is clear continuity of proprietary interest. See Ameri-
can Bronze Corporation v. Commissioner, 64 T.C. 1111, 1123
(1975). |
°Cf. Wortham Machinery Co. v. United States, 521 F.2d 160
(10th Cir. 1975) ; American Bronze Corporation v. Commissioner,
supra at 1124 and n. 8, 10.
=
50a
Appendix C
solution to ensure a ready source of supply is a valid
business purpose, especially where substantial risks are
apparent.
The Court has also held that the requirement of con-
tinuity of business enterprise in the context of reorganiza-
tion qualification’? does not require continuation of the
transferor’s business activity. In American Bronze Cor-
poration v. Commissioner, supra at 1123-24, we held that:
Continuity of business enterprise focuses on the
transferee’s post-merger business. Nowhere does
continuity import a requirement of identity; the
continuing business need not be the same as that
conducted by the transferor. Hrnest F. Becher, 22
T.C. 932 (1954), affd. 221 F. 2d 252 (2d Cir. 1955);
Bentsen v. Phinney, 199 F. Supp. 363 (S.D. Tex.
1961); United States v. Adkins-Phelps, Inc., 400 F.
2d 737 (8th Cir. 1968); Rev. Rul. 63-29, 1963-1 C.B.
77; ef. see. 382(a)(1)(C) and regulations there-
under. Since after the merger petitioner [the trans-
feree corporation] was actively engaged in the con-
duct of its jobbing business the requirement of con-
tinuity of business enterprise is satisfied.
See also Pebble Springs Distilling Co. v. Commissioner,
23 T.C. 196 (1954), affd. 231 F.2d 288 (7th Cir. 1956),
cert. denied 352 U.S. 836 (1956); Morley Cypress Trust,
Schedule “B” v. Commissioner, 3 T.C. 84 (1944).
' Continuity of business enterprise in this context is to be dis-
tinguished from a different doctrine of the same name employed
in Libson Shops, Inc. v. Koehler, 353 U.S. 382 (1957), concern-
ing loss carryovers. See generally Coast Quality Construction Corp.
v. United States, 463 F.2d 503, 510 (Sth Cir. 1972).
dla
Appendiz C
Several “D” reorganization cases have dealt substan-
tively with continuity of the transferor corporation’s busi-
ness and assets. Some cases have approached the prob-
lem in the context of termination of the transferor’s busi-
ness and transfer of its assets to a newly formed, related
corporation for the sole purpose of disposal of those
assets to unrelated parties. These cases have consistently
held that no reorganization occurred because no business
of any kind was conducted by the transferee corporation
after the transfer. Standard Realization Co. v. Commis-
stoner, 10 T.C. 708 (1948); Graham vy. Commissioner, 37
B.T.A. 623 (1938). Also, in Mitchell v. United States, 451
F.2d 1395 (Ct. Cl. 1971), there was no reorganization
when, in furtherance of liquidation, corporate assets were
sold for cash to a pre-existing sister corporation where
the parties intended for the sister corporation to sell the
assets and not retain them for its own use. All salable
assets were sold within a short period of time, although
the sister corporation made some incidental use of a small
amount of the transferor’s equipment in its own business
before disposal."
However, if the transferee corporation receives the
transferor’s assets with the understanding that it will op-
erate any part of the transferor’s business indefinitely and
it does so, then Standard Realization Co., Graham and
Mitchell may be distinguished. Thus, in Lewis v. Commis.
stoner, 176 F.2d 646 (1st Cir. 1949), affg. 10 T.C. 1080
"' Mitchell v. United States, 451 F.2d 1395 (Ct. Cl. 1971), also
predicated its ultimate conclusion, that there was a complete liquida-
tion to which sec. 331 applied, on the finding that there was no
continuation of the transferor’s business after the transfer of its
assets. It expressly did not reach the question of whether the trans-
action met the requirements for a reorganization.
v
52a
Appendia C
(1948), there was a reorganization even though the trans-
feror corporation had attempted to sell all three of its
lines of business, had sold two, and had transferred only
one line to the transferee for operation until a fair price
could be obtained.’* See also American Bronze Corpora-
tion v. Commissioner, swpra.
It is well established that the same business need not
be conducted by the transferee as was conducted by the
transferor. In several cases in which reorganizations were
found, the transferor’s assets have been taken by a newly
formed, related corporation and employed in a different
business. In Pebble Springs Distilling Co. v. Commis-
stoner, swpra, the shareholders of the transferor placed its
distillery assets at auction, but formed a new corporation
to make a minimum bid to prevent a sale below fair value.
The new corporation, after making the high bid for the
assets, rented storage space in part of the distillery facili-
ties but did not engage in distilling. Nevertheless, this
conduct of a different business by the transferee was sufli-
cient to satisfy the reorganization provisions. See also
Morley Cypress Trust, Schedule “B” vy. Commissioner,
supra; Bentsen v. Phinney, 199 F. Supp. 363 (S.D. Tex.
1961).
In these last cases the principal assets transferred were
themselves employed in the changed business conducted by
the transferee corporation. But in Becher v. Commis-
stoner, 22 T.C. 982 (1954), affd. 221 F.2d 252 (2d Cir.
1955), the assets transferred were primarily cash and
assets expected to be turned into cash. Nevertheless, we
held in that case that there was a reorganization, even
12 The assets of this third business were sold less than 3 years
later.
53a
Appendix C
though the transferor’s business had been terminated
prior to the transfer, no going business was transferred
and the’ assets transferred were of the type described.
We explained in Becher v. Commissioner, supra at 941:
The important factor is that [the transferee] was
created to carry on corporate business indefinitely,
although with a different line of manufacture from
that conducted by its predecessor, Cf. Lewis v.
Commissioner, (C. A. 1) 176 F. 2d 646. In the
instant case the reorganization was effected for a
sound “business purpose.” Corporate business was
to be continued indefinitely, and the same share-
holders remained in “control” and their investment
remained “in solution.” Therefore, there was com-
pliance with both the letter and spirit of section
112(g).
Here, as in Becher, there was a sound business pur-
pose for the reorganization, a corporate business was con-
ducted indefinitely by the transferee, and the same stock-
holder remained in control with his investment still in
corporate solution, Aside from the receipt of boot by
Stephan Schaffan, no change in the incidents of taxation
should occur upon the realignment of Fletcher’s operating
assets within the corporate group. Other than that dis-
tribution, there was “no change of substance in the rights
and relations of the interested parties one to another or to
the corporate assets.” Bazley v. Commissioner, 331 U.S.
737 (1947).
The risks and benefits of ownership of Fletcher’s op-
erating assets remained within a corporate vehicle con-
trolled by Stephan Schaffan. They were retained for an
indefinite period for possible use by the surviving cor-
d4a
Appendiz C
porate entity in its business in the event the planned
alteration of the overall corporate operation was not
satisfactory. The facts that Fletcher’s business activity
was halted indefinitely and that the assets transferred
were inactive when received are no more significant
here than was the fact that the principal assets transferred
in Becher were cash or assets expected to be converted to
cash. In both cases, the particular assets were trans-
ferred for reasons germane to the business actively con-
ducted by the transferee corporation. The assets in this
case were “used” by Atlas even while inactive, in the
sense that they performed the function of reducing the
risks of the business. In this sense they performed a
function as integrally related to Atlas’ business as stand-
by generating capacity performs for electric utilities.
We find that there is no general reorganization require-
ment, such as that asserted by petitioners, requiring a
continuation by the transferee of the business activities
of the transferor corporation. We find further that the
facts of the instant case satisfy all existing nonstatutory
reorganization requirements as evidenced in the cases dis-
cussed,
Our research has found statements in a few cases that
would seem to reach a conclusion different than ours, How-
ever, we are not persuaded that these cases establish a
test of reorganization similar to that proposed by peti-
tioners. The bulk of these cases deal with asserted re-
organizations described in section 368(a)(1)(F). See
Home Construction Corporation v. United States, 439
I".2d 1165, 1168 (5th Cir. 1971); Pridemark, Inc. v. Com-
missioner, 345 F.2d 35, 42 (4th Cir. 1965), affg. in part
and revg. in part 42 T.C, 510 (1964); Book Production
Industries, Inc. v. Commissioner, T.C. Memo. 1965-65. We
-
doa
Appendix C
attribute the statements made in these cases regarding
continuation of the transferor’s business to the limitation
of those cases to “kK” reorganizations, to the peculiar
definition of an “F” reorganization, and to the factual
context in which most “F” reorganizations occur. We do
not view these cases as endorsing a general rule for ap-
plication in all reorganizations.
In two cases courts have appeared to take positions
opposed to ours in contexts other than “F” reorganiza-
tions. Mitchell v. United States, supra, has already been
noted. In Wortham Machinery Co. v. United States, 521
F.2d 160 (10th Cir. 1975), affg. 375 F. Supp. 835 (D. Wyo.
1974), one of two commonly controlled corporations ac-
quired the assets of the other in a purported “C” reor-
ganization. However, the transferor had terminated its
business several months before the transfer, and its assets
were of no use to the transferee. The lower court had
limited its opinion to a finding that there was no business
purpose for the reorganization. Wortham Machinery Co.
v. United States, supra, 375 F,. Supp. at 838-39. The pre-
‘cise holding was sustained because it was supported by
substantial evidence, but the court went on to note that
there was no “continuity of business enterprise,” appar-
ently because the transferor’s assets were not employed
in a business conducted by the transferee. See Wortham
Machinery Co. v. United States, supra, 521 F.2d at 163.
No explanation or support was provided for the state-
ments in either Wortham Machinery Co. v. United States,
supra, or Mitchell v. United States, swpra. Each ease
reaches the proper result on grounds other than con-
tinuity of business. In light of our prior analysis, we
do not view these unnecessary statements as authority for
concluding that there must be a continuation by the ac-
56a
Appendix C
quiring corporatfon of the same business enterprise con-
ducted by the transferor in order for the provisions of
section 368(a)(1)(D) to be applicable.
Having found petitioners’ arguments unpersuasive, we
find that in this case all the statutory and nonstatutory
requirements of a reorganization described in section
368(a)(1)(D) are satisfied as determined by respondent.
This finding precludes the application of section 331 to
Stephan and Mildred Schaffan. See Ringwalt vy. United
States, 549 F.2d 89, 91 (8th Cir. 1977); James Armour,
Inc. v. Commissioner, swpra at 310.% The distribution re-
ceived by Stephan Schaffan in 1970 must be treated under
section 356.
Issue 2. Treatment of Distribution to
Stephan Schaffan
Respondent determined that Stephan Schaffan received
a distribution from Fletcher of $482,246.86, and petitioners
have neither presented evidence nor argued that the
amount admittedly received was less than this amount.’* As
18 Because we have found that the facts presented constitute a
reorganization within the meaning of sec. 368 and this forecloses
application of sec. 331, we do not reach the issue raised by respond-
ent, but not argued, that any liquidation that occurred was not a
“complete” liquidation within the meaning of sec. 331. See gener-
ally Telephone Answering Service v. Commissioner, 63 T.C. 423
(1974), affd. 546 F.2d 423 (4th Cir. 1976), cert. denied 431 U.S.
914 (1977).
14 Although petitioners stated in brief that part of this sum was
received in 1971, rather than 1970, they have presented no evidence
that this was the case. Furthermore, they apparently concede the
treatment of the sums as received in 1970.
o7a
Appendix C
our previous discussion shows, this was received in connec-
tion with steps taken pursuant to a plan of reorganization
described in sections 368(a)(1)(D) and 354 and was inte-
grally related thereto. Section 356(a) provides:
Sec. 356. Recerpr or AppIrrionaL CONSIDERATION.
(a) Gain on Exchanges.—
(1) Recognition of Gain.—If—
(A) section 354 or 355 would apply to an ex-
change but for the fact that
(B) the property received in the exchange con-
sists not only of property permitted by section
354 or 355 to be received without the recognition
of gain but also of other property or money,
then the gain, if any, to the recipient shall be recog-
nized, but in an amount not in excess of the sum of
such money and the fair market value of such other
property.
(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 un-
distributed earnings and profits of the corporation
accumulated after February 28, 1913. The remain-
der, if any, of the gain recognized under paragraph
(1) shall be treated as gain from the exchange of
property.
It is clear from paragraph (1) of this subsection that any
gain realized by Stephan Schaffan on the distribution must
58a
Appendix C
be recognized to the extent of the cash received. Further-
more, since Mr. Schaffan was the sole owner of both cor-
porations before and after the distribution, the exchange
certainly has the effect of a dividend within the meaning
of paragraph (2). See DeGroff v. Commissioner, supra at
71. Therefore, the gain recognized by Stephan Schaffan
must be treated as a dividend to the extent of the undis-
tributed earnings and profits of “the corporation.” The re-
mainder of his gain would be properly treated as gain on
the exchange of property.
In South Texas Rice Warehouse Co. v. Commissioner,
43 T.C. 540, 570-72 (1965), affd. in part and rev’d. in
part sub nom. Davant v. Commissioner, 366 F.2d 874 (5th
Cir. 1966), cert. denied 386 U.S. 1022 (1967), we held
that boot received in connection with a “D” reorganiza-
tion was to be treated pursuant to section 356 and that
the earnings and profits against which a dividend is meas-
ured under section 356(a)(2) are oily the earnings and
profits of the transferor corporation in a “D” reorgani-
zation. After reversal on this point by the appellate court,
we had occasion to re-examine our position in American
Manufacturing Co. v. Commissioner, supra. There, with
a thorough discussion, we reaffirmed our position.
Respondent again urges us to reverse our position on
this issue in this case. However, he advances no argu-
ments that were not raised and dismissed in American
Manufacturing Co. v. Commissioner, supra. Our re-ex-
amination of these arguments does not convince us that
our position is in error. For the reasons stated at length
in American Manufacturing Co. v. Commissioner, supra
at 224-31, we hold that the distribution received by Ste-
18 See also Estate of Bell v. Commissioner, supra.
o9a
Appendix C
phan Schaffan is to be treated pursuant to section 356
and that his gain is to be treated as a dividend pursuant
to section 356(a)(2) only to the extent of the undistri-
buted earnings and profits of Fletcher Plastics, Ine.
Issue 3. Inability of Atlas for Fletcher’s Tax Deficiencies
Petitioners have conceded, for purposes of this action,
the tax deficiencies of Fletcher that form the basis of the
notice sent to Atlas in docket No. 7634-74, Atlas Tool
Co., Ine., Successor to Fletcher Plastics, Inc. Therefore,
the only issue remaining in that docket is whether Atlas
is liable for those deficiencies as determined by respond-
ent.
Section 6901'° provides a procedure for collection of
tax liabilities from a transferee" of property from a tax-
16 Sec. 6901. Transferred assets.
(a) Method of Collection —The amounts of the follow-
ing liabilities shall, except as hereinafter in this section pro-
vided, be assessed, paid, and collected in the same manner
and subject to the same provisions and limitations as in the
case of the taxes with respect to which the liabilities were
incurred:
(1) Income, Estate, and Gift Taxes.—
(A) Transferees.—The liability, at law or in equity, of
a transferee of property—
(i) of a taxpayer in the case of a tax imposed by
subtitle A (relating to income taxes), * * *
*1 Sec. 301.6901.1, Income Tax Regs., provide in part:
Sec. 301.6901-1. Procedure in the case of transferred assets.
(Footnote continued on following page)
60a
Appendia C
payer, when the transferee is liable for payment of those
liabilities. This section is merely procedural, however,
and does not create any basis for liability. The exist-
ence and extent of a transferee’s liability for the trans-
feror’s unpaid taxes are determined by state law. Com-
missioner v. Stern, 357 U.S. 39, 45 (1958). On brief, re-
spondent expressly abandoned any claim that Atlas is lia-
ble in equity for the tax liabilities of Fletcher and relied
on its assertion that Atlas is liable at law.’®
(Footnote continued from preceding page)
(b) Definition of transferee. As used in this section, the
term “transferee” includes * * * the shareholder of a dissolved
corporation, * * * the successor of a corporation, a party
to a reorganization as defined in section 368, and all other
classes of distributees. * * *
18 Respondent also pursued on brief assertions that Atlas is “pri-
marily” liable for Fletcher’s tax liabilities, rather than liable as a
transferee, in docket No. 7634-74. However, if the notice mailed
to Atlas in that docket were a notice of deficiency mailed to it as
taxpayer rather than as transferee, the notice would not support
our jurisdiction over the tax liabilities there asserted. The notice
would have been invalid either as a determination with respect to
improper taxable years, see Schick v. Commissioner, 45 T.C. 368
(1966); Atlas Oil & Refining Corporation v. Commissioner, 17
T.C. 733 (1951); Reef Corporation v. Commissioner, 368 F.2d
125 (Sth Cir. 1966), affirming in part and reversing in part a
Memorandum Opinion of this Court, or as a second notice to Atlas
for the same taxable year barred by sec. 6212(c), see Harvey Coal
Corp. v. Commissioner, 12 T.C. 596 (1949). In addition, respond-
ent’s theory is predicated on the applicability of N. J. Stat. Ann.
Sec. 14A:10-6(e) (West 1969), dealing with the effects of a statu-
tory merger or consolidation. See Oswego Falls Corporation v.
(Footnote continued on following page)
6la
Appendix C
As a general rule, a corporation that purchases all of
the assets of another corporation is not liable for the
debts and liabilities of the transferor. Knapp v. North
American Rockwell Corporation, 506 F.2d 361, 364 (3d
Cir. 1974) ; W. Fletcher, Cyclopedia of the Law of Private
Corporations §7122 (perm. ed. 1973). The courts of New
Jersey recognize this rule and have expounded certain
exceptions to it. In McKee v. Harris-Seybold Co., 109
N.J. Super. 555, 264 A.2d 98, 101-02 (Super. Ct. Law
Div. 1970), affd. per curiam 118 N.J. Super. 480, 288 A.2d
585 (Super. Ct. App. Div. 1972), the rule and its ex-
ceptions were stated in the following manner:
It is the general rule that where one company
sells or otherwise transfers all its assets to an-
other company the latter is not liable for the debts
and liabilities of the transferor, including those
(Footnote continued from preceding page)
Commissioner, 26 B.T.A. 60 (1932), affirmed 71 F.2d 673 (2d
Cir. 1934). But see Marion-Reserve Power Co. v. Commissioner,
1 T.C, 513 (1943). It is clear on this record that the requirements
of New Jersey law for statutory merger or consolidation were not
satisfied here. Some confusion exists in certain cases involving
statutory mergers or consolidations as to whether liability of the
transferee for taxes of the transferor is a primary or transferee
liability. However, the cases are clear that absent a statutory mer-
ger or consolidation, where one corporation acquires the assets of
another under the circumstances of the instant case any liability
of the successor corporation for the unpaid taxes of the dissolved
corporation is as a transferee and not as the taxpayer itself. See
California Iron Yards Corporation v. Commissioner, 82 F.2d 776
(9th Cir. 1936), cert. denied 299 U.S. 553 (1937), affirming a
Memorandum Opinion of this Court. Cf. New Colonial Ice Co.
v. Helvering, 292 U.S. 435 (1934); Carnation Milk Products Co.
v. Commissioner, 20 B.T.A. 627 (1930).
62a
Appendia C
arising out of the latter’s tortious conduct, except
where; (1) the purchaser expressly or impliedly
agrees to assume such debts; (2) the transaction
amounts to a consolidation or merger of the seller
and purchaser; (3) the purchasing corporation is
merely a continuation of the selling corporation;
or (4) the transaction is entered into fraudulently
in order to escape liability for such debts. * * *
A fifth exception, sometimes incorporated as an ele-
ment of one of the above exceptions, is the absence
of adequate consideration for the sale or transfer.
** * (Citation omitted.)
See also Wilson v. Fare Well Corporation, 140 N.J. Super.
476, 356 A.2d 458, 463 (Super. Ct. Law Div. 1976).
In our view, it is clear on this record that exceptions
one, four and five, so stated, have no application in this
ease, Fletcher remained in existence until it satisfied its
own known liabilities. The transfer documents for the
assets acquired by Atlas, which apparently were never
executed, contained no assumption of liabilities by Atlas.
The steps taken by Fletcher were taken solely for valid
business reasons, not for any fraudulent purpose. Finally,
the cash payment for the assets of Fletcher in an amount
determined by unrelated appraisers was adequate con-
sideration,
The exceptions for mere continuation of the transferor
and for transactions amounting to mergers or consolida-
tions under New Jersey law have been the subject of liti-
gation in several cases.
Merger and consolidation were described generally as
follows in Applestein v. United Board & Carton Corp-
63a
Appendix C
oration, 60 N.J. Super. 333, 159 A.2d 146, 151 (Super.
Ct. Ch. Div. 1960), affd. per curiam 33 N.J. 72, 161 A.2d
474 (1960) :
A merger of corporations is the absorption by
one corporation of one or more usually smaller
corporations, which lose their identity by becoming
part of the large enterprise. * * * A merger of
two corporations contemplates that one will be ab-
sorbed by the other and go out of existence, but
the absorbing corporation will remain. In a con-
solidation, the two corporations unite and both g£0
out of existence, and a new amalgamated corporate
enterprise takes the place of the former corpora-
tions.
Furthermore, when the substance of a particular com-
bination is that of a merger or consolidation, the New
Jersey courts have applied a doctrine of de facto merger
to give that combination some of the legal effects of a
merger or consolidation. Applestein vy. United Board &
Carton Corporation, swpra at 155; see William B. Riker
& Son Co. v. United Drug Co., 79 N.J. Iq. 580, 82 A. 930
(N.J. 1912); Good vy. Lackawanna Leather Co., 96 N.J.
Super. 439, 233 A.2d 201 (Super, Ct. Ch. Div. 1967). The
court in Applestein v. United Board & Carton Corporation,
supra, 159 A.2d at 154, listed the following factors it
considered in determining that a corporate combination
was a de facto merger:
(1) a transfer of all the shares and all the assets
of Interstate to United; (2) an assumption by
United of Interstate’s liabilities; (3) a “pooling of
interests” of the two corporations; (4) the absorp-
tion of Interstate by United, and the dissolution of
64a
Appendix C
Interstate; (5) a joinder of officers and directors
from both corporations on an enlarged board of di-
rectors; (6) the present executive and operating
personnel of Interstate will be retained in the em-
ploy of United; and (7) the shareholders of the
absorbed corporation, Interstate, as represented by
the sole stockholder, Epstein, will surrender his
1,250 shares in Interstate for 160,000 newly issued
shares in United, the amalgamated enterprise.
The Court noted, however, that each case must be judged
on its own peculiar facts to determine if there is the sub-
stance of a merger. Subsequent cases have noted that all
the factors listed in Applestein v. United Board & Carton
Corporation, supra, are not necessary for a de facto mer-
ger, and several of the factors have been emphasized in
reaching varying conclusions.
Most of the cases dealing with de facto mergers have
arisen in the contexts of products liability suits or share-
holder actions against their corporation. Three cases are
illustrative of those finding de facto mergers. In Apple-
stein vy. United Board & Carton Corporation, supra, the
sole stockholder of the transferor corporation contracted
with the transferee to exchange his stock in the transferor
for a 40 percent stock interest in the transferee, after
which it was planned to liquidate the transferor and op-
erate its assets and business in the transferee corporate
entity. The transferor’s stockholder was to become the
president of the transferee and control its board of di-
rectors. Considering all of the elements of the transac-
tion, the court held that there was more than a mere pur-
chase of stock; there was a de facto merger and, there-
fore, the transferee’s shareholders were entitled to ap-
65a
Appendix C
praisal rights. Wilson v. Fare Well Corporation, supra,
involved two transactions. In both, there was a transfer
of substantially all assets and retention of employees.
The consideration for one transaction was approxi-
mately half stock and half cash, with a correspond-
ing continuity of shareholder interest, and the trans.
feree assumed most of the transferor’s known liabili-
ties. This transaction was held to be a de facto mer-
ger. However, in the other transaction the court held
there could be no merger because there was “no stock
transfer, a different location was used to manufacture the
same product and certain personnel was changed.” Finally,
in Shannon v. Samuel Langston Co., 379 F. Supp. 797
(W.D. Mich. 1974), the district court found a de facto
merger, applying New Jersey law, when all the “operat-
ing assets” were acquired soley for stock of the trans-
feree, the operating personnel and operations were con-
tinued with the transferee in the same location, the trans-
feree assumed all debts and obligations necessary for con-
tinuation of the transferor’s operations, and the transferor
dissolved in due course after distribution of the considera-
tion paid. In explaining its reliance on the fact that stock
was the consideration for the transfer and by way of dis-
tinguishing cases finding no de facto merger, the court ex-
plained that in a case where there was only a cash trans-
fer the stockholders of the transferor “never became a part
of the purchasing corporation.”
As noted in Shannon v. Samuel Langston Co., supra,
the cases finding no de facto merger are characterized by
a lack of continuity of shareholders between the trans-
feror and transferee corporations resulting from acquisi-
tion for cash only and by a concomitant difference in cor-
porate directors and officers. Other characteristics such
66a
Appendix C
as assumption of liabilities, termination of the trans-
feror’s existence, and retention of key employees are not
so commonly held and do not. offer so sharp a contrast
with the cases finding de facto mergers on their facts.
See Menacho v. Adamson United Co., 420 F. Supp. 128
(D. N.J. 1976) ; Wek ee v. Harris-Seybold Co., supra; Good
v. Lackawanna Leather Co., supra.
The cases involving the exception for mere continuation
of the transferor have examined most of the same factors
that are discussed with respect to de facto mergers. It is
apparent that the various factors are considered together
in a manner similar to de facto merger cases in deciding
the applicability of the exception.
In Jackson v. Diamond T. Trucking Co., 100 N.J. Super.
186, 241 A.2d 471, 477 (Super. Ct. Law Div. 1968), the
factors considered in finding a continu.tion were:
(1) transfer of corporate assets (2) for less than
adequate consideration (3) to another corporation
which continued the business operation of the trans-
feror (4) when both corporations had at least one
common officer or director who was in fact instru-
mental in the transfer * * * and (5) the transfer
rendered the transferor incapable of paying its
creditors’ claims because it was dissolved in either
fact or law.
McKee v. Harris-Seybold Co., supra, found no econtinua-
tion where the management, stockholders and directors did
not remain with the transferee. In Wilson v. Fare Well
Corporation, supra, a continuation was found even though
there was no continuity of shareholders. This seemingly
inconsistent position may be explained by the fact that
the parties to the transaction had intended for the trans-
67a
Appendix C
feree “to assume all the benefits and burdens of its pre-
decessor in the continuation of the business” and had pub-
licized their intent. Furthermore, the court was heavily
influenced by policy considerations related to product lia-
bility. See Menacho v. Adamson United Co., supra at 135-
138. We also note that adequacy of consideration was not
considered an additional bar to continuation in McKee v.
Harris-Seybold Co., supra, or a problem in finding con-
tinuation in Wilson v. Fare Well Corporation, supra. In-
adequacy of consideration is suggested as a separate ex-
ception to the general rule of no liability in the New Jer-
sey cases. If it were to be an element of continuation, the
latter exception would be rendered superfluous. In our
view, inadequacy of consideration is not a proper element
of the continuation exception. Cf. Shannon y. Samuel
Langston Co., supra at 801 n. 1.
Under the cases discussed, the applicability of the de
facto merger and continuation exceptions in this case must
ultimately turn on an evaluation of the individual char-
acteristics and the substance of the transactions involving
Atlas, Fletcher and Stephan Schaffan. Initially, we note
that all operating assets and inventory of Fletcher were
transferred to Atlas. These were all the assets necessary
for the continuation of Fletcher’s business operations by
Atlas. Also, all of Fletcher’s employees continued their
employment with Atlas. The shareholders, directors and
officers of Atlas were identical to those of Fletcher. Flet-
cher ceased business activity after the transfer, and its
corporate existence was terminated as promptly thereafter
as possible. All of these factors weigh heavily toward find-
ing both a de facto merger and a continuation of the trans-
feror in this case.
68a
Appendix C
Although the consideration for the transfer was solely
cash and not stock of Atlas, the nature of the considera-
tion is relevant primarily as an indication of shareholder
continuity. See Lopata v. Bemis Co., 406 F. Supp. 521,
526 (E.D. Pa. 1975); Shannon v. Samuel Langston Co.,
supra at 801. Complete shareholder continuity is provided
in this case independently of the consideration paid. Other-
wise, the nature of the consideration would appear to be
of little importance in determining the question of liability.
Creditors of the transferor are not significantly affected
by the nature of the consideration but are more interested
in the value of the consideration and the continued exist-
ence of the debtor.
Atlas neither expressly nor impliedly assumed any lia-
bilities of Fletcher, but we view this common characteris-
tic of mergers as inconsequential under the circumstances.
Fletcher had no long-term liabilities. Its current liabili-
ties were dwarfed by its accounts receivable and cash on
hand, neither of whicl were transferred to Atlas. Thus,
there would appear to be no then known liabilities of
Fletcher that Atlas would have needed to assume for the
orderly continuation of Fletcher’s business. See Shannon
v. Samuel Langston Co., supra at 801 n. 1.
Finally, in all eases finding a de facto merger or con-
tinuation under New Jersey law, and even in most of the
other cases in which the issues were raised, the business
activities of the transferor were carried on by the trans-
feree. This is a fact in the instant case, as well. Here,
Atlas retained Fletcher’s operating assets intact at the
same location. Their partial use was begun within 3
months, and full use was achieved in less than a year.
While the intended interruption of activity is a relevant
consideration in determining the existence of a reorgani-
69a
Appendix C
zation under Federal tax law since it may cireumscribe
the plan of reorganization, the interruption is not of
intrinsic importance to the questions of de facto merger
or continuation under state law. In our view, resumption
of the transferor’s business coupled with the retention
of the assets by the corporation for that specific purpose
should the need arise would be considered sufficient under
New Jersey law to support liability of the successor cor-
poration, and we so hold.
Our discussion of each of these characteristics shows
the strong correspondence between the facts of this case
and de facto mergers and continuations under New J ersey
law. Viewed functionally, no element is missing. Fur-
thermore, the transaction taken as a whole has the sub-
stance of a merger or continuation as described in the
cases discussed. We find under New Jersey law that the
transaction between Atlas and Fletcher was a de facto
merger and that Atlas was the continuation of Fletcher
for purposes of imposing on Atlas the liabilities of Flet-
cher. Therefore, the tax liability asserted in docket No.
7634-74 is properly imposed on Atlas as a transferee at
law of Fletcher.
Issue 4. Accumulated Earnings Tax
In its fiscal years ending June 30, 1969, and June 30,
1970, Atlas produced earnings and profits considerably
in excess of the amounts distributed to its shareholder.
It also consistently experienced substantial profits in the
years prior to those in issue. A very large portion of its
assets were cash or similar liquid assets, The record
shows that Atlas had net liquid assets, the excess of cur-
70a
Appendix C
rent assets over current liabilities, of $2,195,840.33 and
$2,470,804.76, respectively, at the end of the 2 years in
issue.
Respondent determined that Atlas was liable for accu-
mulated earnings taxes for its 1969 and 1970 fiseal years.
The accumulated earnings tax is imposed by section 531”
on corporations which, under section 532,?° are formed or
availed of for the purpose of avoiding the income tax
with respect to their shareholders by permitting earnings
and profits to accumulate rather than being divided or
9 Sec. 531. Imposition of Accumulated Earnings Tax.
In addition to other taxes imposed by this chapter, there is hereby
imposed for each taxable year on the accumulated taxable income
(as defined in section 535) of every corporation described in sec-
tion 532, an accumulated earnings tax equal to the sum of—
(1) 27% percent of the accumulated taxable income not in excess
of $100,000 plus
(2) 38% percent of the accumulated taxable income in excess
of $100,000.
20 Sec. 532. Corporations Subject to Accumulated Earnings Tax.
(a) General Rule.-—The accumulated earnings tax imposed
by section 531 shall apply to every corporation (other than
those described in subsection (b)) formed or availed of for
the purpose of avoiding the income tax with respect to its
shareholders or the shareholders of any other corporation,
by permitting earnings and profits to accumulate instead of
being divided or distributed.
—
7la
Appendia C
distributed to their shareholders. Section 533%" provides
that the fact that earnings and profits are permitted to
accumulate “beyond the reasonable needs of the business”
shall be determinative of the purpose to avoid the income
tax, unless the corporation proves to the contrary. The
“reasonable needs of the business” include the “reason-
ably anticipated” needs of the business. Section 537.22
Petitioners have advanced ordinary and extraordinary
working capital needs as one basis for their accumulation
of earnings and profits. See section 1.537-2(b) (4), Income
Tax Regs. The parties each submitted a so-called “Bar-
dahl” computation® as evidence of Atlas’ normal working
capital needs and then joined issue over the treatment of
Atlas’ letters of credit as an extraordinary working capi-
tal need. Respondent gave no effect to the existence or
payment of the letters of credit. Petitioners’ computation
“Sec. 533. Evidence of Purpose to Avoid Income Tax.
(a) Unreasonable Accumulation Determinative of Purpose.
—For purposes of section 532, the fact that the earnings and
profits of a corporation are permitted to accumulate beyond
the reasonable needs of the business shall be determinative
of the purpose to avoid the income tax with respect to share-
holders, unless the corporation by the preponderance of the
evidence shall prove to the contrary.
#2 Sec. 537. Reasonable Needs of the Business,
For purposes of this part, the term “reasonable needs of
the business” includes the reasonably anticipated needs of
the business.
*3 See Bardahl Manufacturing C or poration v. Commissioner, T.C,
Memo. 1965-200. See generally Ready Paving & Construction Co.
v. Commissioner, 61 T.C. 826 (1974) ; Magic Mart v. Commissioner,
51 T.C. 775 (1969).
72a
Appendix C
assumed that the typical amount of letters of credit out-
standing at a given time were an additional, extraordinary
working capital need. Although the figure used for typical
outstanding letters of credit was in line with the testi-
mony before the Court, petitioners subsequently have ar-
gued that a larger amount, totaling all letters issued dur-
ing the year, should be considered an extraordinary work-
ing capital need.
In our view, in addition to certain errors in computa-
tion, both parties have misunderstood the nature of the
letters of credit and their relationship to Atlas’ working
capital needs. Letters of credit were merely the means
by which Atlas financed most of its imported inventory.
This inventory was ordered, received, and held for sale
by Atlas just like domestically manufactured inventory.
However, the means of payment for the imports differed
in two ways. First and most importantly, cash payment
had to be made for the imports, pursuant to the letters of
credit, 2 to 3 weeks before receipt of the inventory from
the carrier. In its domestic purchases, Atlas was simply
billed upon shipment and paid for the inventory after its
receipt. Second, both Atlas and the bank that issued the
letter of credit were in the position of guaranteeing pay-
ment of the letter during the period from issuance of the
letter to its payment. During the years in issue, Atlas’
line of credit with its bank was in excess of the usual
amount of letters of credit outstanding, and the record
does not show that the bank ever required Atlas to deposit
any sum for payment of the letters until payment was
due. It appears that the bank was willing to issue the
letters simply on the general credit of the corporation.
Atlas itself was in no different position with respect to its
73a
Appendix C
cash needs than if it had ordered the merchandise by ordin-
ary contract and had agreed to pay for it 2 to 3 weeks be-
fore delivery. Thus, the letters of credit did not represent
any extraordinary working capital need, but instead were
simply a component of its normal working capital needs.
With this view of the letters of credit, we may proceed
to evaluate Atlas’ working capital needs. Both petitioners
and respondent computed these needs on the basis of one
operating cycle, and we have found no convincing evidence
that working capital in excess of one operating cycle was
required, Also, the parties included in Atlas’ operating cycle
a period of time necessary to convert inventory into sales
and accounts receivable and a period necessary to collect
the accounts receivable. Respondent subtracted from the
sum of these periods the time extended to Atlas to pay
for its inventory, but petitioners did not. Ordinarily,
respondent’s action would properly reflect the fact that
eredit extended to Atlas would reduce the period of
time its cash was tied up in its inventories and accounts
receivable. In this case, however, approximately half of
Atlas’ inventory was purchased with letters of credit and
this had an effect that was the reverse of extending credit.
Atlas had to pay for this inventory before receipt not
after. The effect of the use of letters of credit was thus
to increase the length of Atlas’ operating cycle with re-
spect to approximately half of its purchases, while the
credit extended on the other half, its domestic purchases,
decreased the cycle. In our view, since the respective
increases and decreases were of approximately the same
length of time, no net adjustment to the operating cycle
is appropriate in this case to reflect Atlas’ financing ar-
rangements with its suppliers.
74a
Appendia C
In computing for the fiscal year ending June 30, 1969,
the length of the operating cycle period between receipt
and sale of inventory, or the inventory turnover period,
both respondent and petitioners divided the average out-
standing inventory by the total inventory sold for the
year, obtaining average inventory turnover periods of 1.15
and 1.25** months, respectively. However, Atlas had a
seasonal sales pattern. The record indicates that Atlas
stockpiled inventory in the months preceding the end of
the fiscal year and that it experienced peaks in its inven-
tory 2 or 3 months after the end of each fiscal year.
Therefore, in our view, the average turnover periods sug-
gested by the parties are too short to reflect the working
capital needs of Atlas as of the end of the year. Based
on a more realistic view of Atlas’ inventory flow, we find
that Atlas’ inventory turnover period on June 30, 1969,
could be expected to be 2 months.
The record indicates that, although Atlas’ inventory
turnover varied seasonally, Atlas did not experience any
significant seasonal variation in collection of its accounts
receivable. Therefore, an average turnover period for
its accounts receivable adequately serves to establish its
operating cycle. Our computation of this period is 1.33
months.
The two periods we have found to be proper compo-
nents of Atlas’ operating cycle represent 27.75 percent
of a year. Atlas’ working capital needs can be said to
be approximated by applying that percentage to the sum
of the yearly operating expenses for which a cash outlay
*4 etitioners’ figure of 1.25 months was based on the use of an
erroneous figure for Atlas’ cost of goods sold, rather than the amount
shown on Atlas’ tax return.
75a
Appendix C
is required and yearly cost of goods sold. These items,
taken from Atlas’ return, total $4,788,907.43. From these
figures we compute Atlas’ approximate working capital
needs as of the end of its 1969 fiscal year to be $1 ,328,-
921.72. In our view, the entire record supports the use
of this figure as a reasonable approximation of working
capital needs, and therefore we find that Atlas had work-
ing capital needs as of June 30, 1969, of $1,328,921.72,
Respondent submitted a “Bardahl” computation for
Atlas’ 1970 fiscal year, but petitioners did not. Respond-
ent’s computation is based on data taken from the bal-
ance sheets included in Atlas’ tax return for that year.
Our examination of these balance sheets causes us to dis-
count heavily respondent’s computation. The balance
sheets show only data at the beginning and end of the
fiscal year. The beginning data, carried forward from
the 1969 return, is in line with similar data for other
years and appears to reflect Atlas’ normal operations.
However, the data for June 30, 1970, radically differs
from that of other years and from Atlas’ normal opera-
tions to a degree that indicates a distortion peculiar to
that particular date. In our view, a “Bardahl” computa-
tion based on these figures would yield only a distorted
estimate of Atlas’ true working capital needs.
We have examined the financial data available to us,
and we have determined that Atlas’ operations in 1970
differed only slightly from those of 1969 in terms of werl-
ing capital needs. For instance, the sum of its cost of
goods sold for the year and its yearly operating expenses
for which a cash outlay was required was $4,781 ,537.24,
only $7,370.19 less than in 1969. Because Atlas’ working
capital needs on June 30, 1970, did not differ significantly
from its needs at the end of the previous fiscal year, we
76a
Appendix C
find that its working capital needs on June 30, 1970, were
$1,328,921.72.
We have found that the funds needed for payment of
Atlas’ letters of credit were not an extraordinary work-
ing capital need, as argued by petitioners, but are ade-
quately reflected in the amount we have found to be its
normal working capital needs. Therefore, the letters of
credit do not represent any additional need for acecumu-
lation of Atlas’ earnings and profits. The only other
basis petitioners advance for this accumulation is pro-
posed expansion and modernization of Atlas’ physical
facilities. See section 1.537-2(b)(1), Income Tax Regs.
The record shows that Atlas had a history of physical
expansion. Buildings were acquired, constructed or ex-
panded in 1948, 1950, 1951, 1952, 1959, 1961, 1964 and
1968. Property was acquired for an additional building
in 1972, and that building was completed in 1975. Peti-
tioners contend that accumulations were necessary in its
fiscal years ending June 30, 1969 and June 30, 1970, for
the expansion that ultimately was evidenced by this last
building.
The future needs of a business may justify a current
accumulation of earnings and profits in appropriate cir-
cumstances. Section 1.537-1(b), Income Tax Regs., pro-
vides :
(b) Reasonably anticipated needs. (1) In order
for a corporation to justify an accumulation of earn-
ings and profits for reasonably anticipated future
needs, there must be an indication that the future
needs of the business require such accumulation,
and the corporation must have specific, definite, and
feasible plans for the use of such accumulation.
77a
Appendix C
Such an accumulation need not be used immedi-
ately, nor must the plans for its use be consummated
within a short period after the close of the taxable
year, provided that such accumulation will be used
within a reasonable time depending upon all the
facts and circumstances relating to the future needs
of the business. Where the future needs of the busi-
ness are uncertain or vague, where the plans for
the future use of an accumulation are not specific,
definite, and feasible, or where the execution of
such a plan is postponed indefinitely, an accumula-
tion cannot be justified on the grounds of reason-
ably anticipated needs of the business.
(2) Consideration shall be given to reasonably
anticipated needs as they exist on the basis of the
facts at the close of the taxable year. Thus, sub-
sequent events shall not be used for the purpose
of showing that the retention of earnings or profits
was unreasonable at the close of the taxable year
if all the elements of reasonable anticipation are
present at the close of such taxable year. However,
subsequent events may be considered to determine
whether the taxpayer actually intended to consum-
mate or has actually consummated the plans for
which the earnings and profits were accumulated.
In this connection, projected expansion or invest-
ment plans shall be reviewed in the light of the
facts during each year and as they exist as of the
close of the taxable year. If a corporation has jus-
tified an accumulation for future needs by plans
never consummated, the amount of such an aceumu-
lation shall be taken into account in determining the
reasonableness of subsequent accumulations.
‘*
78a
Appendix C
See also Faber Cement Block Co. v. Commissioner, 50
T.C. 317, 331 (1968).
Atlas suffered a lack of adequate space frequently. At
various times it rented space for storage purposes. How-
ever, it completed a major expansion in 1968, and the evi-
dence shows that a need for additional space was not ap-
parent for a period in excess of one year. Atlas’ 1969
fiscal year ended on June 30. In our view, Atlas had
formed no specific, definite and feasible plan for expan-
sion by June 30, 1969. If anything, it had only the initial
realization that expansion might be required at some in-
definite time in the future. Property for the expansion
was not acquired until 1972, and active planning did not
begin until 1973. We find that Atlas had no reasonably
anticipated need of funds for expansion on June 30, 1969.
During its 1970 fiscal year, however, we believe the need
for space was of sufficient intensity to spur more conerete
plans for expansion. Obviously, the tangible steps taken
in the following years were not taken without consider-
able thought and planning. The record indicates that dur-
ing 1970 specific, definite and feasible plans were made to
expand Atlas’ facilities. Therefore, we find that on June
30, 1970, Atlas had a reasonably anticipated need of funds
for an expansion of its physical plant.
The amount of Atlas’ need for expansion eapital was
certainly not the amount finally paid for the building
constructed in 1975, however. Only funds for the “rea-
sonably anticipated” needs of the business may be accu-
mulated. The evidence shows that during the planning
stages the anticipated cost of Atlas’ fifth building, inelud-
ing the equipment it was to contain, was only $300,000.
The land acquired for the building in 1972 cost only
$39,000. On this record, we find that Atlas had a reason-
79a
Appendix C
ably anticipated need of no more than $339,000 for ex-
pansion of its facilities on June 30, 1970.
Having found reasonable needs in Atlas’ business for
$1,328,921.72 on June 30, 1969, and $1,667,921.72 on June
30, 1970, it is readily ascertainable that any accumula-
tions of earnings and profits made during either of Atlas’
fiscal years ending on these dates were beyond the rea-
sonable needs of its business. In determining whether
Atlas’ aceumulations violated this standard, it is neces-
sary to determine whether prior accumulations were suffi-
cient to meet its needs in the current years. Bremerton
Sun Publishing Co. v. Commissioner, 44 T.C. 566, 582-83
(1965) ; section 1.535-3(b) (1) (ii), Income Tax Regs. In the
instant case, the record shows that Atlas’ accumulated
earnings and profits on June 30, 1968, the beginning of
the 2 years in issue, were in excess of $1,812,733.70, Of
course, the mere size of the prior accumulation alone does
not establish that it was sufficient for the needs of the busi-
ness. The nature of the accumulation must be considered.
Bremerton Sun Publishing Co. v. Commissioner, supra.
But here the bulk of the accumulation was reflected in
liquid assets. Net liquid assets on June 30, 1968, were
$1,721,905.97. Furthermore, net liquid assets increased
substantially during the year, totaling $2,195,840.33 on
June 30, 1969. In our view, the earnings and profits
accumulated in prior years and reflected on June 30, 1968,
and throughout the 1969 fiscal year in liquid assets were
far beyond the reasonable needs of Atlas’ business during
its 1969 fiscal year. Therefore, we find that any addi-
tional accumulation made during that year was beyond
the reasonable needs of Atlas’ business.
A corresponding analysis shows that at the beginning
of Atlas’ 1970 fiscal year it had accumulated earnings and
80a
Appendix C
profits of at least $2,181,196.70 and net liquid assets of
$2,195,840.33. Net liquid assets grew to. $2,470,804.76
during the fiscal year. Thus, its accumulated earnings
and profits reflected in liquid assets far exceeded the
amount of those assets we have found to be reasonable
needs of the business, $1,667,921.72. We find that any
amount of earnings and profits accumulated during Atlas’
1970 fiscal year was beyond the reasonable needs of its
business.
Since any earnings and profits not distributed to Atlas’
shareholder during its 1969 and 1970 fiscal years were
accumulated beyond the reasonable needs of its business,
section 533 dictates the imposition of the accumulated
earnings tax unless Atlas has proved by a preponderance
of the evidence that it was not formed or availed of for
the purpose of avoiding the income tax with respect to
its shareholder by means of the accumulation. The ree-
ord shows that Stephan Schaffan was taxed on his mar-
ginal income at the highest income tax rates. Atlas was
taxed at lower corporate rates. Although Stephan Schaf-
fan’s salary of $75,000 might be considered adequate, it
was not generous considering that he was the moving
foree behind a growing and profitable business. Atlas
listed no loans to its shareholder during the years in issue,
but on these facts this only indicates that Stephan Schaf-
fan had no use for the additional funds at the time. Fur-
thermore, although Atlas paid dividends in the years in
issue, the amounts were small compared to the company’s
profits and considering that it had no need for a large
part of its liquid funds. On this record, we find that Atlas
has failed to prove that it was not availed of for the
purpose of avoiding the income tax with respect to its
shareholder by permitting its earnings and profits to ac-
mumulate. Therefore, Atlas is subject to imposition of
8la
Appendix C
the accumulated earnings tax for its fiscal years ending
June 30, 1969, and June 30, 1970, as determined by re-
spondent.
Decisions will be entered
under Rule 155.
82a
APPENDIX D
Judgment of the United States Court of Appeals for the
Third Circuit
UNITED STATES COURT OF APPEALS FOR THE
THIRD CIRCUIT
Nos. 78-2631/78-2632
»
—
ATLAS TOOL CO., INC.,
Petitioner,
VS.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
(Tax Court Docket No. 7633-74)
ATLAS TOOL CO., INC., Successor to
Fletcher Plastics, Inc.,
Petitioner,
VS.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
(Tax Court Docket No. 7634-74)
STEPHAN SCHAFFAN and MILDRED SCHAFFAN,
Petitioners,
VS.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
*
83a
Appendix D
»
—_
(Tax Court Docket No. 7635-74)
ATLAS TOOL CO., INC., ATLAS TOOL CO., INC.,
Successor to Fletcher Plastics, Inc., STEPHAN
SCHAFFAN and MILDRED SCHAFFAN,
Appellants in No. 78-2631,
COMMISSIONER OF INTERNAL REVENUE,
Appellant in No. 78-2632.
APPEAL FROM A DECISION oF THE Unirep States Tax Court
=
a
Present: Grsspons and Hiaarnsoruam, Circuit Judges and
Werner, District Judge*
JUDGMENT
This cause came on to be heard on the record from
the United States Tax Court, and was argued by counsel
on October 15, 1979.
On consideration whereof, it is now here ordered, ad-
judged and decreed by this Court that the decision of
the said Tax Court in this cause be, and the same is
hereby affirmed. Costs taxed in favor of appellee in ap-
peal No. 78-2631 and in favor of appellees in appeal No.
78-2632.
ATTEST:
THomas F, Quinn
Clerk
January 28, 1980
* Honorable Charles R. Weiner, United States District Judge
for the Eastern District of Pennsylvania, sitting by designation.
84a
APPENDIX E
Order Extending Time to File Petition for a
Writ of Certiorari
SUPREME COURT OF THE UNITED STATES
No. A-922
STEPHAN SCHAFFAN AND MILDRED SCHAFFAN,
Petitioners,
¥.
COMMISSIONER OF INTERNAL REVENUE
Orver Extenpinc Time to Fite ror Writ or CERTIORARI
i.
~~
Upon Consiperation of the application of counsel for
petitioner(s),
Ir Is Orvrerep that the time for filing a petition for
writ of certiorari in the above-entitled cause be, and the
same is hereby, extended to and including June 26, 1980.
/s/ William J. Brennan, Jr.
Associate Justice of the Supreme
Court of the United States
Dated this 29 day of April, 1980.
85a
APPENDIX F
Statutes Involved
Interal Revenue Code of 1954 (26 U.S.C.):
Parr II—Corroratre Ligumations
Sec. 331. Gary or Loss to SHAREHOLDERS IN CorPORATE
LIQUIDATION.
(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.
(2) Partial Liquidations—Amounts distributed in
partial liquidation of a corporation (as defined in
section 346) shall be treated as in part or full pay-
ment in exchange for the stock.
Sec. 337. Garn or Loss on Sates orn EXCHANGES IN Con-
NECTION WitH Certain LiqumpATIoNns.
[See. 337(a) ]
(a) General Rule—If—
(1) a corporation adopts a plan of complete liqui-
dation on or after June 22, 1954, and
(2) within the 12-month period beginning on the
date of the adoption of such plan, all of the assets
of the corporation are distributed in complete liqui-
dation, less assets retained to meet claims,
then no gain or loss shall be recognized to such cor-
poration from the sale or exchange by it of prop-
erty within such 12-month period.
. * . *
\
86a
Appendia F
Part I[I[—Corporatte ORGANIZATIONS AND REORGANIZATIONS
Sec. 354.—Excuances or Stock anp Securities tn CrEr-
TAIN REORGANIZATIONS.
(a) General Rule.—
(1) In General.—No gain or loss shall be recog-
nized 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 securi-
ties in such corporation or in another corporation a
party to the reorganization.
(2) Limetation—Paragraph (1) shall apply if—
(A) the principal amount of any such securities
surrendered, or
(B) any such securities are received and no
such securities are surrendered.
(3) Cross Reference.—
For treatment of the exchange if any property is
received which is not permitted to be received un-
der this subsection (including an excess principal
amount of securities received over securities sur-
rendered), see section 356,
(b) Haception.—
(1) In general.—Subsection (a) shall not apply
to an exchange in pursuance of a plan of reorgani-
zation within the meaning of section 368(a)(1)(D),
unless—
(A) the corporation to which the assets are
transferred acquires substantially all of the assets
of the transferor of such assets; and
87a
Appendix F
(B) the stock, securities, and other properties
received by such transferor, as well as the other
properties of such transferor, are distributed in
pursuance of the plan of reorganization.
(a) Cross Reference.—
For special rules for certain exchanges in pur-
suance of plans of reorganization within the mean-
ing of section 368(a)(1)(D), see section 355.
Sec. 356. Receret or AppITIONAL CONSIDERATION.
(a) Gain on Exchanges.—
(1) Recognition of gain.—if—
(A) section 354 or 355 would apply to an ex-
change but for the fact that
(B) the property received in the exchange con-
sists not only of property permitted by section 354
or 355 to be received without the recognition of
gain but also of other property or money.
then the gain, if any, to the recipient shall be recog-
nized, but in an amount not in excess of the sum of
such money and the fair market value of such other
property.
(2) Treatment as divided.—If an exchange is de-
scribed 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 corpora-
tion accumulated after February 28, 1913. The
8Sa
Appendix F
remainder, if any, of the gain recognized under
paragraph (1) shall be treated as gain from the
exchange of property.
Sec. 368. Derinitions RELATING TO CoRPORATE REORGAN-
IZATIONS.
(a) Reorganzation.—
(1) In General_—For purposes of parts I and
II and this part, the term “reorganization” means—
(D) a transfer by a corporation of all or a
part of its assets to another corporation if im-
mediately after the transfer the transferor, or
one or more of its shareholders (including per-
sons 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 are transferred are dis-
tributed in a transaction which qualifiies under
section 354, 355, or 356;
Sec. 531. Imposition or ACCUMULATED EArninas Tax.
89a
APPENDIX G
House Conference Report No. 2543
“Liquidation followed by reincorporation——The house
bill in section 357 contained a provision dealing with a
device whereby it has been attempted to withdraw cor-
porate earnings at capital gains rates by distributing all
assets of a corporation in complete liquidation and prompt-
ly 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 in
the part of the House that, at the present time, the pos-
sibility of tax avoidance in this area is not sufficiently
serious to require a special statutory provision. It is be-
lieved that this possibility can appropriately be disposed
of by judicial decision or by regulation within the frame-
work of the other provisions of the bill.” H. Conference
Rep. No. 2543, 83rd Cong. 2d Sess., p. 41 (3 U.S.C. Cong.
& Adm. News (1954) 5280, 5301).
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.