Appendix — Vulcan Materials Co. v. United States

Aen Ohta

APPENDIX

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

OctosEer TERM, 1976

No. 30116 & 30117

D.C. Docket No. CA 65-61 & CA 65-333

Vutcan MarerraL: Company, Plaintiff-Appellant,

v.

Unitep States or America, Defendant-Appellee.

Appeals from the United States District Court for the

Northern District of Alabama

Before Bey, AinswortH and Axpisert,* Circuit Judges,

Judgment

This cause came on to be heard on the transcript of the

record from the United States District Court for the

Northern District cf Alabama, and was argued by coun-

sel;

On ConsmeraTION WueEnreor, It is now here ordered and

adjudged by this Court that the judgment of the said

District Court in tnis cause be, and the same is hereby,

affirmed ;

It is further ordered that plaintiff-appellant pay to de-

fendant-appellee, the costs on appeal to be taxed by the

Clerk of this Court.

May 28, 1971

Issued As Mandate: July 6, 1971.

* Of the Third Circuit, sitting by designation.

2a

[Filed June 25, 1971}

_ UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

Octoser Term, 1970

No. 30116 & 30117

Vutcan Martertats Company, Plaintiff-Appellant,

Vv.

Unrrep States or America, Defes-dant-Appellee.

Appeals from the United States District Court for the

Northern District of Alabama

(June 25, 1971)

Before Bett, ArnsworTH and Aupisert,* Circuit Judges.

On Petition for Rehearing

Per CurRIAM:

Ir Is OnpErep that the petition for rehearing filed in the

above entitled and numbered cause be and the same is

hereby denied.

* Of the Third Circuit, sitting by designation.

3a

IN THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

Nos. 30116 & 30117

Vutcan Marteriars Company, Plaintiff-Appellant,

v.

Unirep States or America, Defendant-Appellee.

Appeals from the United States District Court for the

Northern District of Alabama

(May 28, 1971)

Before Bexx, AtnswortH and ALpIsERT,*

Circuit Judges.

AupiseRT, Circuit Judge: Two principal issues are pre-

sented by these appeals from the district court’s denial

of federal income tax refunds: (I) whether organization

or reorganization expenses incurred by appellant’s prede-

cessors, and concededly capital in nature and not deductible

when incurred, became deductible upon the occurrence of

statutory mergers carried out pursuant to 26 U.S.C. § 368

(a)(1)(A); (II) whether appellant met its burden of over-

coming the Commissioner’s determination that one of its

predecessors, Follansbee Steel Corporation, had acquired

two other corperations for the principal purpose of tax

avoidance. If appellant did not satisfy this burden, it is

conceded that net operating loss carryovers were properly

disallowed under 26 U.S.C. § 269(a) (2).

A stipulation of facts with accompanying documentary

exhibits constituted the sole evidence at trial. No oral

testimony was offered. The salient facts are summarized

in the opinion of the district court, 308 F. Supp. 53, 54

55 (N.D. Ala. 1969) :

* Of the Third Circuit, sitting by designation.

4a

On December 23, 1954, Consumers Company (Con-

sumers) and Frontier Chemical Company (Frontier),

both Delaware corporations, were merged into a third

Delaware corporation theretofore named Follansbee

Steel Corporation (Follansbee). Prior to the afore-

mentioned merger, Follansbee disposed of all of its

operating assets. Upon merger, the corporation owned

approximately nine million dollars in liquid assets and

had an approximate six million dollar net operating

loss. In the merger proceedings, the name of the

surviving corporation was changed from Follansbee

Steel Corporation to Union Chemical and Material

Corporation (Union Chemical). On December 31, 1957,

Union Chemical was merged into the plaintiff. Each

-of the aforementioned mergers constituted reorgani-

zations within the meaning of Section 368(a)(1)(A)

of the Internal Revenue Code of 1954....

in 1934, the predecessor of Consumers filed a peti-

tion in the United States District Court for the North-

ern District of [Illinois for a reorganization under

Section 77B of the Bankruptcy Act. During the period

1933 through 1937, various expenditures were incurred

with respect to the reorganization and to the organi-

zation of the former corporation into Consumers.

Likewise, Follansbee’s predecessor filed a petition in

bankruptcy in 1934 and in 1940 was reorganized into

Follansbee Steel Corporation. In 1946, a further cor-

poration merged with Follansbee and as a result of

’ the reorganization and merger, expenses were alleged

to have been incurred. Each of the aforementioned ex-

penditures is conceded to be capital in nature and thus

not deductible when paid or incurred. -

On its 1957 corporate income tax return, Union

Chemical deducted all of the aforementioned expenses.

A subsequent audit resulted in the disallowance of

these deductions, followed by a deficiency assessment

— Se

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totaling $369,453.93 which was paid. A claim for re-

fund of this amount was filed and thereafter reject-

ed on the theory that the aforementioned expenditures

were capital in nature and not deductible upon merger.

The Internal Revenue Service further refused to

make a refund based on a depletion allowance on the

ground that plaintiff had improperly carried over

Follansbee’s premerger net operating losses in contra-

vention of Sec. 269 of the 1954 Code. Although the

deficiency which resulted from the carry-forward was

not assessable due to the bar of the statute of limita-

tions, it was nevertheless of sufficient size to offset

any recovery to which the plaintiff might otherwise

have beer entitled. On March 24, 1965, plaintiff’s .

claim for refund was formally rejected.

Prior to December 23, 1954, the date on which Con-

sumers and Frontier merged into Follansbee, the lat-

ter corporation disposed of all of its machinery, tools,

inventory, etc., which it used in its steel operation;

hence, the corporation was but a mere shell. However,

on the date of merger its sole possessions consisted of

approximately nine million dollars in liquid assets and

approximately a six million dollar net operating loss

which it could not utilize due to the abatement of its

operations. The companies which merged into Fol-

lansbee were engaged in the stone and chemical busi-

ness. Following the merger, the new entity continued

to operate profitably. In each of the years 1955, 195€

and 1957, portions of the pre-merger net operating

_ loss suffered by Follanshee were used to offset the pro-

fits of the Consumers and Frontier enterprises.

6a

| 4

Reorganization Expenses

It is well established that recapitalization or reorganiza-

tiou expenditures of a corporation are not ordinary and

necessary business expenses but rather capital expendi-

tures which are not deductible when incurred. General

Bancshares Corp. v. Commissioner, 326 F.2d 712 (8 Cir.),

cert. denied, 379 U.S. 832 (1964); Bush Terminal Bldgs.

Co. v. Commissioner, 204 F.2d 575 (2 Cir. 1953) ; Missouri-

Kansas Pipe Line Co. v. Commissioner, 148 F.2d 460 (3

Cir. 1945). In Godfrey v. Commissioner, 355 F.2d 82, 85

(6 Cir. 1964), the court stated:

An expenditure is of a capital nature ‘‘where it results

in the taxpayer’s acquisition or retention of a capital

asset, or in the improvement or development of a capi-

tal asset in such a way that the benefit of the expendi-

ture is enjoyed over a comparatively lengthy period

of business operation.’’ Louisiana Land & Explora-

tion Co. 1. Commissioner, 7 T.C. 507, aff’d. 161 F.2d

842, C.A. 5 [(1947)]....

While appellant concedes that the capital expenditures were

not deductible when paid or incurred, the government ac-

knowledges that capital expenditures of the nature here

involved may be deducted upon the dissolution and liquida-

tion of a corporation. Bryant Heater Co. v. Commissioner,

231 F.2d 938 (6 Cir. 1956); Commissioner v. Wayne Coal

Mining Co., 209 F.2d 152 (3 Cir. 1954); Shellabarger

Grain Products Co. v. Commissioner, 146 F.2d 177 (7 Cir.

1944; Koypers Co. v. United States, 278 F.2d 946 (Ct. CL

1960) ; Pacific Coast Biscuit Co. v. Commissioner, 32 B.T.A.

39 (1935) ; Malta Temple Assn. v. Commissioner, 16 B.T.A.

409 (1929).

The issue here is whether the organization or reorgani-

zation expenses of appellant’s predecessors may now be

claimed as deductions, as urged by appellant, or whether

the distinctions between dissolution and merger will pre-

clude such deductions in a merger situation.

7a

A statutory merger! effects a combination of two or

more corporations in accordance with the detailed proce-

dures established by the corporatiou laws of a state, with

one of the corporations continuing as the same legal en-

_ tity it was before the transaction. Stated differently, a

merger is

the absorption of one corporation by another, which

retains its name and corporate entity with the added

capital, franchises and powers of the merged cor-

poration. It is the uniting of two or more corpora-

tions by the transfer of property to one of them, which

continues in existence, the others being merged there-

in.

15 FietcHer, Cyctopepia or Corporations § 7041. See

Argenbright v. Phoenix Finance C., 21 Del. Ch. 288, 187

A. 124 (1936); Fidanque v. American Maracaibo Co., 92

A.2d 311 (Del. Ch. 1952)). Thus, the distinguishing charac-

teristics of a merger are (1) an assumption by the surviv-

ing corporation ‘‘of all the rights and liabilities of the

disappearing entitles,’’ 8 Cavircu, Bustness ORGANIZATIONS

§ 167.07[2], and (2) the cessation of the ‘‘separate exis-

tence of all the ccnstituent corporations . . . except the one

into which the other or others of such constituent corpora-

tions have been merged.’’ 8 Del. Code Anno. § 259(a).

A corporate dissolution, on the other hand, represents

the termination of the corporation’s existence as a legal

person. Once corporate existence ends, so do the privileges,

powers, rights and duties which arose from corporate ex-

istence, except for specific purposes recognized by opera-

tion of law. 8 Cavircn, supra, § 185.02.

The term ‘‘dissolution’”’ as applied to a corporation,

signifies the extinguishment of its franchise to be a

?See 8 Del. Code Anno. § 251 et seq. and 14 N.J. Stat. Anno.

14:21-1 et seq. for the statutory provisions of the states in which

the corporations were organized.

8a

corporation and the termination of its corporate ex-

istence. It has been described as that condition of

law and fact which ends the capacity of the ine a

porate to act as such and necessitates a liquidation

and extinguishment of all legal relations existing in

respect of the corporate enterprise. It denotes the

complete destruction of the corporation, and, within

contemplation of law, is equivalent to its death, being

sometimes likened to the death of a natural person.

16A FLETCHER, supra, § 7866.?

Thus, although in both a statutory merger and a dissolu-

tion the merged or dissolved corporate entity ceases to

exist, fundamental distinctions inhere in the two processes.

In a dissolution, the privileges, powers, rights and duties

of the corporation come to an end and suffer a corporate

death.* In a merger, these attributes of corporate life are

transferred to the surviving corporation and are there

continued and preserved. It has been said that ‘‘all ‘rights,

powers, liabilities and assets’ [survive] except the ‘in-

dicia and attributes of a corporate body distinct from that

2 Dissolution and liquidation refer to entirely separate concepts:

a liquidation has no direct effect upon the existence or non-existence

of the corporate entity; it concerns the settling of the corporate

affairs, t.e., gathering assets, accounting with creditors and debtors,

and apportioning the profit or loss to its stockholders. Farmers’

State Bank & Trust Co. v. Brady, 137 Tex. 39, 152 S.W.2d 729

(1941); In re Burger’s Estate, 276 Mich. 485, 267 N.W. 887

(1936) ; Browne v. Hammett, 133 So.C. 446, 131 S.E. 612 (1926);

Gibson v. American Ry. Express Co., 195 Iowa 1126, 193 N.W.

274 (1923).

3““From the time of that entry [order of dissolution] the cor-

poration has been dead, all its agencies ended, its employees, in-

cluding attorneys, discharged: and is put, without exception or

notice of appeal, beyond all future corporate activity.’’ State ex

rel. Attorney General v. Fidelity Loan & Trust Co., 113 Iowa 439,

440, 85 N.W. 638-39 (1901).

9a

into which it is merged.’ ’’ Citizens Trust Co. v. Commis-

stoner, 20 B.T.A. 392, 393 (1930).

Recognizing these distinctions, we accept the govern-

ment’s contention that the provision for deduction of capi-

tal expenditures upon dissolution of a corporation is not

applicable when the corporation becomes a constituent of a

surviving corporation in a merger. The organization and

reorganization expenses of the constituent corporations in

the case at bar were clearly capital in nature. These as-

sets were not lust but were continued beyond the corporate

existence of the constituent corporations and persisted as

capital assets of the surviving corporation. So construed,

the expenses were not deductible.

II.

Operating Loss Carryover

Appeal No. 30,1775 requires us to decide whether the

net operating loss incurred by Follansbee Stee] Corporation

in its taxable year 1954, which was not absorbed by its

* Another point was raised for our consideration in the appeal

at 30,116: whether payment by Cons1mers Company, 4 predecessor

corporation, to the state of Illinois, allegedly for the privilege of

doing business, qualifies as a deduction. Upon proof that payment

was made to the State of Illinois for that purpose and that such

right was duplicative or no longer necessary, it could be a proper

subject for consideration. We are not persuaded, however, that

appellant met the appropriate burden of proof. The stipulation,

8 (p) merely states:

Secretary of State of Illinois—$3,209.24. The amount listed

was paid to the Secretary of State of Illinois for various serv-

ices including fees for ministerial and recording services re-

quired under applicable state laws of Illinois.

° The parties stipulated that if it is concluded that the net operat-

ing losses are not aliowable as deductions under section 172 by

reason of section 269, the taxpayer will not be entitled to any

recovery in Appeal No. 30,117 because taxpayer’s indebtedness to

the United States exceeds the amount claimed in these actions.

10a

taxable income or that of its successor Union Chemical

and Material Corporation in taxable years prior and sub-

sequent thereto, was allowable to Union Chemical as a de-

duction for its taxable year 1957 pursuant to 26 U.S.C.

§ 172. The Commissioner disallowed the deduction by rea-

soa of section 269(a)(2),° finding that the principal pur-

pose of the merger of Follansbee (the loss corporation)

and Consumer and Frontier (profit corporations), was to

utilize the net operating loss of Follansbee to offset future

income of the surviving corporation.

Follansbee discontinued its steel operations and sold

its assets prior to the merger in 1954. Thus, by the time

of the merger it had become a ron-operating corporation

with liquid assets of $9,000,000.00, and a net operating loss

of $6,000,000.00 resulting from the sale of assets. Follans-

6 Internal Revenue Code of 1954, 26 U.S.C.:

§ 269. Acquisitions made to evade or avoid income taz.

(a) In general—If—

(1) any person or persons acquire, or acquired on or after

October 8, 1940, directly or indirectly, control of a corpora-

tion, or

(2) any corporation acquires, or acquired on or after Oc-

tober 8, 1940, directly or indirectly, property of another cor-

poration, net controlled, directly or indirectly, immediately

before such acquisition, by such acquiring corporation or its

stockholders, the basis of which property, in the hands of the

acquiring corporation, is determined by reference to the basis

in the hands of the transferor corporation, and the principal

purpose for which such acquisition was made is evasion or

avoidance of Federal income tax by securing the benefit of a

deduction, credit, or other allowance which such person or

corporation would not otherwise enjoy, then [such deduction,

credit, or other allowance be disallowed]. For purposes of

paragraphs (1) and (2), control means the ownership of stock

possessing at least 50 percent of the total combined voting

power of Jl classes of stock entitled to vote or at least 50

percent of tae total value of shares of all classes of stock of

the corporation.

lla

bee successfully claimed the carryback against income

earned and reported in taxable years pricy to 1954 as a

deduction under Section 172. What the Con missioner chal-

lenged was the attempt by Union Chemical, the successor

corporation after the merger, to take advantage of the

loss carryback of Follansbee.

Immediately prior to the merger, Frontier was actively

operating in the field of chemicals, and Consumer in build-

ing materials, coal and ice. Following the merger, stock-

holders of the loss corporation, Follansbee, obtained 576

controlling interest in the surviving corporation, which

continued the former operations of Frontier and Concrumer

with its corporate name changed to Union Chemical.

Although the acquisition of a controlling stock interest

in a corporation may serve multiple purposes, if the pri-

mary or single most important purpose of the acquisi-

tion is tax avoidance or evasion, tax benefits are barred.”

* Section 269 was ‘‘desiened to put an end promptly to any

market for, or dealings in, interests in corporations or property

which have as their objective the reduction through artifice of the

income or excess profits tax liability.”” H. Rep. No. 871, 78th

Cong., Ist Sess., 49 (1944 Cum. Bull. 901. 938). The Senate Re-

port to the Revenue Act of 1943 makes it clear that the proscribed

purpose exists ‘‘if the evasion ar avoidance purpose outranks or

exceeds in importance, any other one purpose.’’? H. Rep. No. 627,

78th Cong., Ist Sess., 59 (1944 Cum. Bull. 973, 1017).

Treasury Regulations on Incoine Tax (1954 Code) (26 C.F.R.)

provide:

§ 1.269-3 Instances in which section 269(a) disallows a deduc-

tion, credit, or other allowance.

(a) Instances of disallowance. Section 269 specifies two

instances in which a deduction, credit or other allowance is to

be disallowed. These instances [are] described in paragraphs

(1) and (2) of section 269(a)....

In either instance the principal purpose for which the acquisition

was made must have been the evasion or avoidance of Federal in-

12a

In Southland Corp. v. Campbell, 358 F.2d 333, 336 (5 Cir.

1966), this court emphasized that section 269 ‘‘is applicable

only in certain carefully circumscribed situations—it may

be invoked only where there has been an acquisition of

control, the principal purpose of which is evasion or avoid-

ance of taxes.’’ (Emphasis by the court). The statute

defines ‘‘control’’ as the ownership of stock possessing at

least 50 percent of the total combined voting power of all

come tax by securing the benefit of a deduction, credit, or other

allowance which such persor or persons, or corporation, would not

otherwise enjoy. If this requirement is satisfied, it is immaterial

by what method or by what conjunction of events the benefit was

sought. Thus, an acquiring person or corporation can secure the

benefit of a deduction, credit, or other allowance within the mean-

ing of section 269 even though it is the acquired corporation that

is entitled to such deduction, credit, or other allowance in the de-

termination of its tax. If the purpose to evade or avoid Federal

income tax exceeds in importance any other purpose, it is the prin-

cipal purpose. This does not mean that only those acquisitions fall

within the provisions of section 269 which would not have been

made if the evasion or avoidance purpose was not present. The

determination of the purpose for which an acquisition was made

requires a scrutiny of the entire circumstances in which the trans-

action or course of conduct occurred, in connection with the tax

result claimed to arise therefrom. For the presumption of a prin-

cipal purpose of tax evasion or avoidance, see section 269(c) and

§ 1.269-5.

8In Southland the loss corporation was Carribean, a shipping

business in which Murchison Brothers had a 50 percent ownership.

The profitable corporation was Old Cabell’s, engaged in the dining

and grocery business. Murchison stockholders, the majority stock-

holders in Old Cabell’s, gave to Caribbean their stockholdings in

Old Cabell’s, and later donated back to Caribbean substantial

shares of Caribbean stock. Subsequently the two corporations

merged, with Caribbean being the surviving corporation. The

court held that the acquisition portion of 269(a) was not met be-

eause ‘‘immediately before Caribbean acquired control of it, Old

Cabell’s was controlled by the stockholders of Caribbean, and,

therefore, under the express terms of the statute it is not appli-

cable.’’ 358 F.2d at 337.

$

13a

classes of stock entitled to vote, or at least 50 percent of

the total value of shares of all classes of stock. See 2

Raskin & JoHNson FepERau Income, Girr & Estate Taxa-

TION, § 11.05.

Thus, we are concerned with twe Ines of inquiry: (a)

whether there has been an acquisition of control® as con-

templated by section 269, and, if So, (b) whether the

principal purpose of the merger was to evade or avoid

taxes.

It is important to recognize what is not before us. We

do not have a single corporation, which, with no change

in stock ownership, discontinued a losing business and en-

tered a totally different venture which proved to be profit-

able; nor do we have a single corporation which experienced

® The government urges that this case may turn on the test set

forth in Revenue Ruling 63-40: Where there is no change in stock

ownership either before the discontinuance of its former business

activity or after the commencement of its new business activity,

the net operating loss deduction is allowable. But where there is

“‘more than a minor change in stock ownership of a loss corpora-

tion which acquires a new business enterprise, the Service may

continue to contest the deductibility of the carry-over of the cor-

poration’s prior losses against income of the new business enter-

prise.’” We consider this a simplistic approach. The question is

not the amount of stock ownership change, but the effect of the

change upon control.

Addressing itself to the question of control, Technical Informa-

tion Release No. 773 of the IRS dated October 13, 1965, declared:

‘‘where there has been both a 50 per cent or more shift in the

benefits of a loss carryover (whether direct or indirect and includ-

ing transactions having the effect of shifting the benefits of the

loss by shifting assets, stock, profit interests or other valuable

rights) and a change in business as defined in section 382/a) and

the regulations thereunder,’’ the doctrine of I4bson Shops Ine. v.

Koehler, 353 U.S. 382 (1957) will be applied: ‘a surviving cor-

poration in a merger may not carry over and deduct pre-merger net

operating losses of one business against post-merger income of

another which was operative and taxed ‘separately before the

merger.’’ Rev. Ruling 58-603, TIR-89, August 25, 1958.

Sn ae seers

l4a

a subsianv’al change in ownership in the same taxable

year in whic. the ‘‘corporation [had] not continued a trade

or business su stantially the same as that conducted before ©

the change in the percentage ownership’’ of the stock. 26

U.S.C. § 382(a): nor did the situation here involve a statu-

tory merger of several corporations, each of which con-

ducted substantially the same business prior to the merger,

with no basic post-merger change of stock ownership, as

in Libson Shops Inc. v. Koehler, 353 U.S. 382 (1957); nor

did a corporation which, after reorganization ir which there

had not been a 50 percent change in the bereficial owner-

ship of the loss, engage in substantially the same business,

as in United States v. Jackson Automobile, Inc., (sic) 371

F.2d 808 (5 Cir. 1967) ; nor was there a merger of two cor-

porations, each of which was controlled by the same stock-

holders prior to the merger as in Southland Corp. v.

Campbell, supra; nor was this a statutory merger in which

the surviving corporation conducted a business substan-

tially different from that previously operated by the loss

corporation but with only a minor change in the beneficial

ownership of the ioss, Rev. Rul. 63-40.

What we do have is: (1) a substantial change in the

beneficial ownership of the loss, but not one which exceeds

50 percent, for the original stockholders of Follansbee, who

owned 100 percent cf the loss corporation stock, became

owners of 57 percent of the surviving corporation of the

merger; (2) a substantial change in the beneficial owner-

ship of a profitable corpuration—these same stockholders

who had no ownership before the merger became owners

of 57 percent thereafter; (3) a subsequent operation of a

business substantially different from that previously con-

ducted by the loss corporation.

Because the Follansbee stockholders who owned 100 per-

cent of the pre-merger loss corpo.ation ultimately owned

over 50 percent of the acquiring corporation, and. because

there ‘was no surrender of 50 percent of the beneficial

‘

e ’

15a -

ownership of the loss, it is suggested that a provision of

the Commissioner’s Technical Information Release No. 773,

supra, note 9, if literally applied, would authorize the

deduction:

The Service will not rely on Libson Shops under the

1954 Code in any loss carryover case where there has

been less than a 50 percent change in the beneficial

- ownership of the ioss or where there has been no

change in business as defined in section 382(a) and the

regulations thereunder. However, the Ser ice will

continue to rely on sections 269 and 482, where ap-

propriate, in dealing with the carryover of losses.

Revenue Ruling 63-40, C. B. 1963-1, 46 will be modified

to the extent inconsistent herewith.

We do not quarrel with this statement as far as it goes.

But the mischief in relying solely upon IRS technical re-

leases and revenue rulings is that, for the most part, they

speak to the limited fact situations before the Service at

that moment. They do not purport to be comprekensive

statements of substantive law. From tkis terse technical

information release we cannot conclude that it is only a

change in the beneficial ownership of the loss which will

determine the allowance vel non of a net operating loss

carryover.

Indeed, this court has deemed it settled that section 269

‘fis applicable when a ‘loss’ corporation acquires control

of a ‘profitable’ corporation since the acquiring corporation

thereby secures the benefit of a loss it would not have

otherwise enjoyed. F. C. Publication Inquidating Corp.

v. Commissioner, 304 F.2d 779, 781 (2 Cir. 1962).’? South-

land Corp. v. Campbell, supra, 358 F.2d at 336. In F. C.

Publication Liquidating Corp., supra, the court denied a

loss carryover. The loss corporation acquired a profitable

corporation, giving the shareholder majority interest in

the surviving corporation. Theve, as here, the business of

the loss corporation was not continued ; the surviving cor-

16a

poration carried on the business previously conducted by

the profitable corporation. Thus, these cases adhere to the

principle enunciated in Urban Redevelopment Corp. v.

Commissione;, 294 F.2d 328, 332 (4 Cir. 1961):

It is now well established that the deduction should

be disallowed when ... it is claimed by either the ac-

quired corporation or by the person who acquired

control of the corporation and who will get the bene-

fit of the deduction, albeit, indirectly.

In this case there was a shift of 57 percent of the

ownership of a profitable corporation. Therefore, consider-

ing solely the question of ‘‘control,’’ we are persuaded

that there was an acquisition cf the control, under section

269, of profitable corporations which gave the acquiring

corporation ‘‘the benefit of a loss it would not have other-

wise enjoyed.’? £. C. Publication Liquidating Corp. v.

Commissioner, supra.

Paramount in our approach to the troublesome ques-

tion of the merger’s primary purpose is a recognition that

the 26 U.S.C. -§ 269 does not foreclose the right of an ac-

quiring corporation to take advantage of a past operating

loss. Congress did not close the door to a proper and

legitimate use of the net operating loss deduction by a

successor corporation to a statutory merger. Moreover,

even the change in control of either the beneficial owner-

ship of the loss or profitable constituent corporations will

not preclude the proper utilization »f the operating loss

carryover deduction. Congress sought to deny tax bene-

fits only to those corporate acquisitions in which ‘‘the pri-

mary purpose... is evasion or avoidance of Federal in-

come taxes.’’ |

Thus, if Follansbee’s acquisition of the chemical and

buildizg materials companies was motivated by legitimate

business reasons, that tax considerations played a role,

even an important role, would not defeat the right to tax

benefits so long as the tax considerations did not constitute

VO LL LT:

17a

the ‘‘principal purpose”’ of the merger. Only ‘‘if the pur-

pose to evade or avoid Federal income tax exceeds in im-

portance any other purpose, [is it] the principal pur-

pose.’”’ Treasury Reg. 41.269-3(a) (2).

There are several significant factors present in the

events which gave rise to this appeal. The net op-

erating loss itself is not questioned. It resulted from a

sale of Follansbee assets in 1954, which took place prior

to the December 23, 1954 merger. As noted, the Com-

missioner did not question the right of Follansbee to use

this loss to offset earned income in years prior to 1954.

It was only when Union Chemical, the successor corpora-

tion to the three-company merger, attempted to stand in

the shoes of Follansbee, after the merger, and apply this

loss to offset post-merger earned income that the Com-

missioner denied the deduction and made the determina-

tion of tax liability.

The taxpayer made the payment under protest, and sued

for a refund. In such a proceeding, which is in the na-

ture of a common law action for money had and received,

the burden is on the taxpayer to prove that the Commis-

sioner’s determination of the tax was erroneous. Lewis

v. Reynolds, 284 U.S. 281, 283 (1932). Moreover, in Bob-

see Corp. v. United States, 411 F.2d 231, 238 (5 Cir. 1969)

(footnote omiited), this court said:

The burden of proving that tax avoidance was not the

‘ principal purpose is on the taxpayer. Theoretically

the question of purpose is purely subjective; pragma-

tically, however, the trier of fact can only determine

purpose from objective facts. Thus, unless the tax-

payer can muster facts sufficiently plausible to con-

vince the trier of the purity of his motives, the IRS

will prevail.

As indicated above, there was no oral testimony adduced

at trial. Pertinent facts to this issue were presented in

paragraphs 31-34 of the written stipulation No explicit

18a

statement for the purpose of the merger may be gleaned

from paragraphs 31 and 32. Paragraph 33 delineated

what financial equities were brought to and received by the

merged group, and this was expressed only in statements of

fair market value and book value. In addition, a refer-

ence was made to Follansbee’s proxy statement and to a

jisting of shares. Paragraph 34 described the net operat-

ing loss carryover.

There is nothing explicit in the stipulation which de-

scribes the purpose of the merger. Therefore, we must

look for illumination to Exhibit ‘‘C’’ which is ‘‘K. Sum-

mary’’ of the Proxy Statement issued by Follansbee to its

shareholders prior to the meeting which approved the pro-

posed merger. From the meager information therein pre-

sented, it becomes apparent that Follansbee had con-

verted its assets to cash at some point before the stock-

holders’ meeting.”® We are not old, nor does the record

disclose, the precise date of the sale of assets, or whether

the sale was a Follansbee decision separate and apart

from the proposed merger with Frontier and Consumer and

independent of a proposed merger with any other com-

panies. We are not told whether there was any contem-

plation of liquidation at the time of the sale of assets.

The proxy statement does disclose, however, the reason

for the sale of assets—Follansbee’s ‘‘relatively insecure

position in the steel industry.’?* From the standpoint

10 Paragraph 33 indicates that as of September 9, 1954, Follans-

bee has already a liquid position showing cash of $9,286,620. Ob-

vicusly the sale of assets took place before this date.

11‘*Tn considering the reason for the sale of Follansbee assets.

Follansbee’s relatively insecure position in the steel industry was

discussed. Mention was also made of the present outlook of the

industry generally. The most widely accepted index to conditions

in the steel industry is the rate of operations as compared to

capacity. Each month since January, 1953, the industry-wide rate

of operations, has shown, except for minor and relatively insig-

nificant recoveries, a steady decline... .’’

19a

of the taxpayer’s burden at trial, some proof of au us-

sociation vetween the sale of assets with the precise merger

would have been helpful. Even more persuasive would

have been some evidence, if available, that the reason for

the merger was Follansbee’s lack of confidence in the

future of the steel industry and a corresponding coui-

dence in the future of the business of the acquired cor-

porations.’? Absent proof of a relationship between the

sale of the assets and the ultimate merger, it becomes dif-

ficult to conclude that the stated business purpose of the

sale of assets was also the business purpose of the merger.

Conspicuously absent from the trial record was a state-

ment by any Follansbee official, or corporate minutes, serv-

ing to contradict the Commissioner’s conclusion that the

primary purpose of the merger was tax evasion or avoid-

ance or stating affirmatively the actual purpose for the

merger. At best, the purpose had to be divined by the

court from an examination of a portion of a proxy state-

ment which, inter alia, contained the statement:

As previously stated, the sale and merger will cre-

ate a carry-forward tax loss estimated by tax counsel

at approximately $4,500,000. This means that the

first $4,500.00 of profits earned by the Continuing

Corporation through the anticipated successful opera-

tion of Consumers’ and Frontier will not be subject to

Federal Income Tax."

12 The proxy statement included an analysis of Frontier’s chem-

ical operation and a sketchy description of Consumer’s business.

13 The proxy statement also stated:

The Continuing Corporation, by virtue of the sale of Follans-

bee assets, will be in a position to supply substantial amounts

of additional needed capital to both Frontier and Consumers.

20a

Accordingly, in exercising our review responsibilities '

we have carefully examined the entire record to resolve the

issue upon which this appeal will turn: Did the taxpayer

meet its burden of proving that the Commissioner’s deter-

mination was in error? We are persuaded that the tax-

payer did not meet its burden. It offered no substantial

evider ‘e of business purpose and chose to rest its case on

the skeletal, tightly worded factual stipulation and on a

proxy statement. We do not intimate an absolute ne-

cessity for testimony denying that tax: avoidance was the

primary purpose of the merger, alth¢ugh such testimony,

augmented with affirmative statemofits or proof of appro-

priate business purpose, would hve formidably strength-

ened this taxpayer's case. At the very minimum, however,

for the taxpayer to have prevailed, some substantial evi-

dence should have been introduced by way of explanation

of the business purpose for the merger.

AFFIRMED.

14 We reject the government’s invitation to decide this appeal on

the clearly erroneous doctrine. Bay Sound Transp. Co. v. United

States, 410 F.2d 505 (5 Cir. 1969). Since there was no oral testi-

mony and no necessity to decide the credibility of witnesses, the

fact finder enjoyed no advantages not possessed by us as a court

of review.

2la

Relevant Provisions of the General Corporation Law of New

Jersey Contained in What Is Designated as “Title 14 Cor-

porations General.” the Various Sections of Which Are

Designated as “§ 14:1-1,” Etc.

14:12-1. Corporations WuicH May Merce or Conso-

DATE.—Any two or more corporations organized under any

law or laws of this state, or any corporation organized

under the laws of any other state for the purpose of carry-

ing on any kind of business of the same or a similar nature,

may merge or consolidate into a single corporation, which

may be either one of such merging or consolidating corpo-

rations, or a new corporation under the laws of this state

to be formed by means of such merger and consolidation;

provided, that a merger or consolidation of a corporation

of another state, so proposed to be merged or consolidated

with such New Jersey corporation, is authorized by the

laws of such other state.

The provisions of this chapter relative to merger and

consolidation shall not apply to any railroad, turnpike, in-

surance, canal or banking companies, savings banks, or

other corporations intended to derive profit from the loan

or use of money.

14:12-2. Procepure; Joint AGREEMENT.—The directors

of the several corporations proposing to merge or consoli-

date shall enter into a joint agreement under the corporate

seals of the respective corporations for their merger or

consolidation, prescribing:

a. The terms and conditions of the merger or con-

solidation and the mode of carrying it into effect;

b. The name of the new corporation, if one shall be

so formed or created, or of the consolidated corpora-

tion, as the case may be;

ce. The number, names and post-office addresses of the

first directors and officers of the new or consolidated

corporation, who shall hold office until their successors

22a

are chosen or appointed, either according to law or the

by-laws of the new corporation, and in case of the cre-

ation of a new corporation, how and when the directors

and officers shall be chosen or appointed;

d. The number of shares of the capital stock of the

new or consolidated corporation, whether common or

preferred, and, if any such stock has nominal or par

value, the amount or the par value of such shares;

e. The manner of converting the capital stock of each

of such merging or consolidating corporations into the

stock or obligations of the new or consolidated cerpo-

ration; and

f. Such other provisions and details as the first men-

tioned directors shall deem necessary to perfect the

merger or consolidation.

14:12-3. AGREEMENT; SUBMISSION TO STOCKHOLDERS;

Fiuinc; Certiriep Cory To Be Evivence.—The agreement

shall be submitted to the stockholders of each of the merg-

ing or consolidating corporations at separate meetings

thereof, called for the purpose of considering the same, upon

twenty days’ notice of the time, place and object thereof,

mailed to the last known post-office address of each of such

stockholders. At each of such stockholders’ meetings a

vote of the stockholders shall be taken by ballot, cast in

person or by proxy, for the adoption or rejection of such

agreement, each share of stock entitling the holder to one

vote.

14:12-5. Ricuts anp Powers; Duties anp LIABILITIES.—

When such merger or consolidation is effected, all the

rights, privileges, powers and franchises of each of such

corporations, both of a public and private nature, all real

and personal property, all debts due on any account, as well

for stock subscriptions as all other things in action or be-

longing to each of the corporations, and all and every other

interest, shall vest in the consolidated corporation as effec-

23a

tually as they were vested under the laws of this state in

any of such corporations by deed or otherwise, shall not

revert or be in any way impaired by reason of this chapter.

All rights of creditors and all liens upon the property of

the former corporations shall be preserved unimpaired, and

the respective former corporations may be deemed to con-

tinue in existence in order to preserve the same, and all

debts, liabilities, restrictions and duties of the former cor-

porations shall thenceforth attach to such consolidated cor-

poration, and may be enforced against it to the same extent

as if they had been incurred or contracted by it.

14:13-4. Corporate Entity Continvep ror Purpose oF

Wixpine Up.—All corporations, whether they expire by

their own limitation or be annulled by the legislature or be

otherwise dissolved, shall be continued bodies corporate for

the purposes of prosecuting and defending suits by or

against them, of enabling them to settle and close their

affairs, of disposing of and conveying their property and of

dividing their capital, but not for the purpose of continuing

the business for which they were established.

14:13-1. Dissotution; Procepure.—Every corporation

organized under this title may be dissolved in the following

manner:

The board of directors. shall pass a resolution, declaring

it advisable and most for the benefit of the corporation that

it be dissolved and calling a meeting of the stockholders to

take action thereon. The meeting shall be held upon such

notice as the by-laws provide, and in the absence of such

provision, upon ten days’ notice given personally or by

mail. If two-thirds in interest of all the stockholders,

whether with or without voting powers and without regard

to class, shall at such meeting or any adjournment thereof

vote in favor of the dissolution of the corporation and con-

sent thereto in writing, a certificate of such dissolution

shall be made by the corporation under its seal and the

hands of the president or vice president and the secretary

24a

or assistant secretary. The certificate shall be acknowl-

edged or proved as in the case of deeds of real estate, and,

together with such consents in writing and a list of the

names and post-office addresses of the difeetors or officers

certified as aforesaid, shall be filed in the office of the secre-

tary of state, who shall thereupon issue a certificate that

such certificates and consents have been filed. Upon the

issuance of such dissolution certificate by the secretary of

state the corporation shall thereupon be dissolved, except

as hereinafter provided, and the board of directors shall

proceed to settle up and adjust its business and affairs, ex-

cept that the consent in writing of the stockholders may fix

a date subsequent to the date of the issuance of such cer-

tificate by the secretary of state as the date on which the

dissolution shall take eect, which shall be stated in the

certificate issued by the secretary of state. Whenever all

the stockholders shall consent in writing to a dissolution,

no meeting or notice thereof shall be necessary, but on fil-

ing such consents in the office of the secretary of state he

shall forthwith issue a dissolution certificate. The board

of directors shall in every case cause such certificate of the

secretary of state to be published for three weeks succes-

sively, at least once in each weekly in a newspaper published

in the county in which the principal office of the corporation

was last located, and shall, after the completion of such

publication, file proof thereof in the office of the secretary

of state.

——~

Extracts From “General Corporation Law of the State of Dela-

ware” (Which Now Constitute a Part of Title 8 of the

Delaware Code 1953).

Sec. 251 Consolidation or merger of domestic corporations

‘*(a) Any two or more corporations organized under the

provisions of this chapter, or existing under the laws of this

State, for the purpose of carrying on any kind of business,

may consolidate or merge into a single corporation which

may be any one of said constituent corporations or a new

25a

corporation to be formed by means of such consolidation or

merger as shall be specified in the agreement required by

subsection (b) of this section.’’

‘*(b) The directors, or a majority of them, of such cor-

porations as desire to consolidate or merge, may enter into

an agreement signed by them and under the corporate seals

of the respective corporations, prescribing the terms ard

conditions of consolidation or merger, the mode of carrying

the same into effect, and stating such other facts required

or permitted by the provisions of this chapter to be set out

in certificates of incorporation, as can be stated in the case

of a consolidation or merger, stated in such altered form as

the circumstances of the case require, as well as the manner

of converting the shares of each of the constituent corpora-

tions into shares or other securities of the corporation re-

sulting from or surviving such consolidation or merger,

with such other details and provisions as are deemed neces-

sary. Any such agreement may provide for the payment

of cash in lieu of the issuance of fractional shares of the

resulting or surviving corporation.”’ (Formerly part of

Section 59 of the Delaware Corporation Law).

Sec. 252 Consolidation or merger of domestic and foreign

corporations; service of process upon surviving

corporation

‘*(a) Any one or more corporations organized under the

provisions of this chapter, or existing under the laws of this

State, may consolidate or merge with one or more other

corporations organized under the laws of any other state or

states of the United States, if the laws under which the

other corporation or corporations are formed shall permit,

such consolidation or merger. ‘The constituent corpora-

tions may merge into a single corporation, which may be

any one of the constituent corporations, or they may con-

solidate to form a new corporation, which may be a corpo-

ration of the State of incerporation of any one of the con-

26a

stituent corporations as skJl be specified in the agreement

required by subsection (b) of this section.’’

ad

‘*(b) All the constituent corporations shall enter into an

agreement in writing which shal! prescribe the terms and

eonditions of the consolidation or merger, the mode of car-

rying the same into effect, the manner of converting the

shares of each of the constituent corporations into shares

or other securities of the corporation resulting from or sur-

viving such consolidation or merg2r and such other details

and provisions as shall be deemed necessary or proper.

There shall also be set forth in the agreement such other

facts as shall then be required to be set forth in certificates

of incorporation by the laws of the state which are stated

in the agreement to be the laws that shall govern the result-

ing or surviving corporation and that can be stated in the

case of a consolidation or merger. Any such agreement

may provide for the payment of cash in lieu of the issuance

of fractional shares of the resulting or surviving corpora-

tion.’’ (Formerly part of Section 59 of the Delaware Cor-

poration Law).

See. 259. Status, rights, liabilities, etc., of constituent and

surviving corporations following merger or con-

solidation

‘*(a) When an agreement of consolidation or merger shall

have been signed, acknowledged, filed and recorded, in ac-

cordance with the requirements of this subchapter, or upon

the effective date of the merger if otherwise stated in the

certificate, for ali purposes of the laws of this State the

separate existence of all the constituent corporations, par-

ties to said agreement, or of all such constituent corpora-

tions except the one into which the other or others of such

constitutent corporations have been merged, as the case

mav be, shall cease and the constituent corporations shall

become a new corporation, or be merged into one of such

corporations, as the case may be, in accordance with the

provisions of said agreement, possessing all the rights,

privileges, powers and franchises as well of a public as of

27a

a private nature and being subject to all the restrictions,

disabilities and duties of each of such corporations so con-

solidated or merged; and all and singular, the rights, privi-

leges, and all property, real, personal and mixed, including

in the case of banks or trust companies, without any order

or action on the part of any court or otherwise, appoint-

ments, designations, and nominations and all other rights

and interests as trustee, executor, administrator, registrar

of stocks and bonds, guardian of estates, assignee, receiver,

trustee of estates of lunatics and in every other fiduciary

capacity, and all debts due to any of said constitutent cor-

porations on whatever account, as well for stock subscrip-

tions as all other things in action or belonging to each of

such corporations shall be vested in the corporation result-

ing from or surviving such consolidation or merger; and

all property, rights, privileges, powers and franchises, and

all and every other interest shall be thereafter as effectu-

ally the property of the resulting or surviving corporation

as they were of the several and respective constituent cor-

porations, and the title to any real estate vested by deed or

otherwise, under the laws of this State, in any of such

constituent corporations, shall not revert or be in any way

impaired by reason of this chapter; but all rights of cred-

itors and all liens upon any property of any of said con-

stituent corporations shall be preserved unimpaired, and

all debts, liabilities and duties of the respective constituent

corporations shall thenceforth attach to said resulting or

surviving corporation, and may be enforced against it to

the same extent as if said debts, liabilities and duties had

been incurred or contracted by it.”? (Formerly Section

60(a) of the Delaware Corporation Law).

Sec. 261. Effect of consolidation or merger upon pending

actions

‘“‘Any action or proceeding pending by or against any of

the corporations consolidated or merged may be prosecuted

as if such consolidation or merger had not taken place, or

the corporation resulting from or surviving such consolida-

tion or merger may be substituted in its place.’’

e

28a

Extracts From “Agreement of Merger Among Consumers Com-

pany, Frontier Chemical Company and Follansbee Steel

Corporation, Dated: As of September 13, 1954” (Exhibit B

to Proxy Statement).

Section 1

‘‘Subject to the conditions in Section 11 and elsewhere

herein set forth, as soon as this Agreement of Merger shall

have been approved by the votes of holders of the capital

stock of Consumers, Frontier, and Follansbee, in accord-

ance with the requirements Title 8 of the Delaware Code

of 1953 and such facts shall have been certified by the Sec-

retary or Assistant Secretary of each of said Corporations

under their respective corporate seals and this Agreement

of Merger so certified shall have been signed, acknowl-

edged, filed and recorded, all as required by the provisions

of Section 251 of the Delaware Code of 1953, thereupon

said three corporations shall become a single corporation,

to-wit: Follansbee, which shall survive the merger. The

date npon which Consumers and Frontier shall be so merged

into Follansbee is hereinafter referred to as ‘the effective

date of this Agreement of Merger,’ and the single corpora-

tion, Follansbee, which shall survive the merger, is some-

times hereinafter called the ‘Surviving Corporation.’ ”’

Section 2

‘*Except as hereinafter otherwise specifically set forth,

Follansbee, the Surviving Corporation, its identity, exist-

ence, purposes, powers, objects, franch:ses, rights and im-

munities shall continue unaffected and unimpaired by the

merger, and the corporate franchises, entity, existence and

rights of Consumers and Frontier shall be merged into

Follansbee, and Follansbee shall be fully vested therewith

on and after the effective date of this Agreement of Merger.

The separate existence of Consumers and Frontier, except

as it may be continued by statute, shall cease, and Consum-

ers and Frontier shall be merged into Follansbee in accord-

ence with the provisions of this Agreement of Merger.’’

29a

Relevant Portions of Illinois Law Effective in 1937

Through 1954.

“157.102. § 102. Admission of Foreign Corporation. A

foreign corporation organized for profit, before it transacts

business in this State, shall procure a certificate of author-

ity so to do from the Secretary of State. A foreign corpo-

ration organized for profit, upon complying with the pro-

visions of this Act, may secure from the Secretary of State

a certificate of authority to transact business in this State,

but no foreign corporation shail be entitled to procure a

certificate of authority under this Act to transact in this

State the business of ‘banking, insurance, suretyship, or a

business of the character of a building and loan corpora-

tion. A foreign corporation shall not be denied a certificate

of authority by reason of the fact that the laws of the state

under which such corporation is organized governing its

organization and internal affairs differ from the laws of

this State, and nothing in this Act contained shall be con-

strued to authorize this State to regulate the organization

or the internal affairs of such corporation.

**157.106. § 106. Application for certificate of authority.

A foreign corporation, in order to procure a certificate of

authority to transact business in this State, shall make ap-

plication therefor to the Secretary of State, which applica-

tion shail set forth:

‘“‘(a) The name of the corporation and the state or

country under the laws of which it is organized...

“157.135. § 135. License fees payable by foreign corpo-

rations. The Secretary of State shall charge and collect

from each foreign corporation authorized to transact busi-

ness in this State the following license fees, cethputed on

the basis and at the rates prescribed in this Act:

‘‘(a) An initial license fee at the time of filing its

application for a certificate of authority to transact

business in this State. ...

30a

‘157.136. § 136. Basis of computation of license fees

payable by foreign corporations. The basis for the initial

license fee payable by a foreign corporation shall be the

amount represented in this State, determined in accordance

with the provisions of this section, of the sum of its stated

capital and paid-in surplus. ...

157.137. § 137. Rate of license fees payable by foreign

corporations. The initial license fee and all additional li-

7 cense fees payable by a foreign corporation shall be com-

j puted at the rate of one-twentieth of one per cent of the

‘ basis prescribed in this Act for the computation of the ini-

tial license fee and additional license fees, respectively.

Relevant Portions of Internal Revenue Code of 1954.

68A Stat. 18

‘¢See. 63. Taxable Income Defined.

“*(a) General Rule——Except as provided in subsection

(b), for purposes of this subtitle the term ‘taxable income’

means gross income, minus the deductions allowed by this

chapter, other than the standard deductions allowed by part

IV (sec. 141 and following).

68A Stat. 45

‘Sec. 161. Allowance of Deductions.

‘‘In computing taxable income under section 63(a), there

shall be allowed as deductions the items specified in this ¢

part, subject to the exceptions provided in part [X (sec. 261

and following, relating to items not deductible).

‘¢Sec. 165.

‘“‘(a) General Rule——There shall be allowed as a deduc-

tion any loss sustained during the taxable year and not

compensated for by insurance or otherwise.

‘“(b) Amount of Deduction—For purposes of subsection

(a), the basis for determining the amount of the deduction

3la

for any loss shall be the adjusted basis provided in section

111 for determining the loss from the sale or other dispo-

sition of property... .”’

68A Stat. 63

‘‘Sec. 172. Net Operating Loss Deduction.

‘*(a) Deduction Allowed—There shall be allowed as a

deduction for the taxable year an amount equal to the ag-

gregate of (1) the net operating loss carryovers to such

year, plus (2) the net operating loss carrybacks to such

year. For purposes of this subtitle, the term ‘net operat-

ing loss deduction’ means the deduction allowed by this

subsection.

‘*(c) Net Operating Loss Defined.—For purposes of this

section, the term ‘net operating loss’ means (for any tax-

able year ending after December 31, 1953) the excess of the

deductions allowed by this chapter over the gross income.

Such excess shall be computed with the modifications speci-

fied in subsection (d).

**(d) Modifications—The modifications referred to in

this section are as follows:

‘*(4) Nonbusiness deductions of taxpayers other than

corporations.—In the case of a taxpayer other than a

corpora.ion, the deductions allowable by this chapter

which are not attributable to a taxpayer’s trade or busi-

ness shall be allowed only to the extent of the amount

of the gross income not derived from such trade or

business. For purposes of the preceding sentence—

‘*(A) Any gain or loss from the sale or other dis-

position of—

‘*(i) property, used in the trade or business, of

a character which is subject to the allowance for

depreciation provided in section 167, or

32a

‘*(ii) real property used in the trade or busi-

ness, shall be treated as attributable to the trade

or business;...

68A Stat. 80

‘<Sec. 269. Acquisitions made to Kvade or Avoid Income

Tax.

‘“(a) In General.—If—

‘*(1) any person or persons acquire, or acquired on

or after October 8, 1940, directly or indirectly, control

of a corporation, or

‘*(2) any corporation acquires, or acquired on or af-

ter October 2, 1940, directly or indirectly, property of

another corporation, not controlled, directly or indi-

rectly, immediately before such acquisition, by such

acquiring corporation or its stockholders, the basis of

which property, in the hands of the acquiring corpora-

tion, is determined by reference to the basis in the

hands of the transferor corporation.

and the principal purpose for which such acquisition was

made is evasion or avoidance of Federal income tax by se-

curing the benefit of a deduction, credit, or other allowance

which such person or corporation would not otherwise en-

joy, then the Secretary or his delegate may disallow such

deduction, credit, or other allowance. For purposes of

paragraphs (1) and (2), control means the ownership of

stock possessing at least 50 percent of the total combined

voting power of all classes of stock entitled to vote or at

least 50 percent of the total value of shares of all classes of

stock of the corporation.

‘‘(c) Presumption in Case of Disproportionate Purchase

Price.—The fact that the consideration paid upon an acqui-

sition by any person or corporation described in subsection

(a) is substantially disproportionate to the aggregate—

**(1) of the adjusted basis of the property of the

corporation (to the extent attributable to the interest

33a

acquired specified in paragraph (1) of subsection (a),

or of the property acquired specified in paragraph (2)

of subsection (a); and

‘*(2) of the tax benefits (to the extent not reflected

in the adjusted basis of the property) not available to ©

such person or corporation otherwise than as a result

of such acquisition.

‘shall be prima facie evidence of the principal purpose of

evasion or avoidance of the Federal income tax. This sub-

section shall apply only with respect to acquisitions after

March 1, 1954.

68A Stat. 124

‘‘Sec, 381. (a) Genzrat Rutz.—In the case of the acquisi-

tion of assets of a corporation by another corporation—

‘*(1) in a distribution to such other corporation to

w..ich section 332 (relating to liquidations of subsidi-

aries) applies, except in a case in which the basis of

the assets distributed is determined under section 334

(b)(2); or

‘*(2) in a transfer to which section 361 (relating to

nonrecognition of gain or loss to corporations) applies,

but only if the transfer is in connection with a reorgan-

ization described in subparagraph (A), (C), (D) (but

only if the requirements of subparagraphs (A) and (B)

of section 354(b)(1) are met), or (F) of section 368

(a) (1),

‘*the acquiring corporation shall succeed to and take into

account, as of the close of the day of distribution or trans-

fer, the items described in subsection (c) of the distributor

or transferor corporation, subject to the conditions and

limitations specified in subsections (b) and (c).

34a

‘‘(c) Items of the Distributor or Transferor Corpora-

tion.—The items referred to in subsection (a) are:

‘*(1) Net Operating Loss Carryovers.—The net

operating loss carryovers determined under ‘section

172, subject to the following conditions and limitations:

‘*(A) The taxable year of the acquiring corpora-

tion to which the net operating loss carryovers of the

distributor or transferor corporation are first carried

shall be the first taxable year ending after the date

of distribution or transfer... .

68A Stat. 129

‘‘Sec. 382. (a) Purchase of a Corporation and Change in

its Trade or Business.—

‘*(1) In General.—lIf at the end of a taxable year of

a corporation—

‘“‘(A) Any one or more of those persons de-

scribed in paragraph (2) own a percentage of the

total fair market value of the outstanding stock of

such corporation which is at least 50 percentage

points more than such person or persons owned at—

‘*(i) the beginning of such taxable year, or

‘*(ii) the beginning of the prior taxable year,

‘*(B) the increase in percentage points at the end

of such taxable year is pttributable to—

‘¢(i) w purchase by such person or persons of

such stock, the stock of another corporation own-

ing stock in such corporation, or an interest in a

partnership or trust owning stock in such corpora-

tion, or

‘‘(ii) a decrease in the amount of such stock

outstanding or the amount of stock outstanding of

ano‘her corporation owning stock in such corpora-

35a

tion, except a decrease resulting from a redemp-

tion to pay death taxes to which section 303

applies, and

‘*(C) such corporation has not continued to carry

on a trade or business substantially the same as that

conducted before any change in the percentage

ownership of the fair market value of such stock,

‘“‘the net operating loss carryovers, if any, from prior

taxable years of Such corporation to such taxable year and

subsequent taxable years shall not be included in the net

operating loss deduction for such taxable year and sub-

sequent taxable years.

‘*(2) Description Person or Persons.—The person or

persons referred to in paragraph (1) shall be the 10

persons (or such lesser number as there are persons

owning the outstanding stock at the end of such

taxable year) who own the greatest percentage of the

fair market value of such stock at the end of such

taxable year; except that, if any other person owns

the same percentage of such stock at such time as is

owned by one of the 10 persons, such person shall

also be included. If any of the persons are so related

that such stock owned by one is attributed to the other

under the rules specified in paragraph (3), such

persons shall be considered as only one person solely

for the purpose of selecting the 10 persons (more or

less) who own the greatest percentage of the fair

market value of such outstanding stock.

‘*(3) Attribution of Ownership.—Section 318 (re-

lating to constructive ownership of stock) shall apply

in determining the ownership of stock, except that

sections 318(a)(2)(C) and 318(4)(3)(C) shall be

applied without regard to the 50 percent limitation

contained therein.

‘(4) Definition cf Purchase—For the purposes of

this subsection the term ‘purchase’ means the acquisi-

36a

tion of stock, the basis of which is determined solely

by reference to its cost to the holder thereof, in a

transaction from a person or perso.s other than the

person or persons the ownership of whose stock would

be attributed to the holder by application of paragraph

(3).

‘*(b) Change of Ownership as the result of a Reorganiza-

tion.—

‘*(1) In General.—If, in the case of a reorganization

specified in paragraph (2) of section 381(a), the trans-

feror corporation or the acquiring corporation—

‘“‘(A) has a net operating loss which is a net

operating loss carryover to the first taxable year

of the acquiring corporation ending after the date of

transfer, and

‘‘(B) the stockholders (immediately before the

reorganization) of such corporation (hereinafter in

this subsection referred to as the ‘loss corporation’),

as the result of owning stock of the loss corporation,

own (immediately after the reorganization) less

than 20 percent of the fair market value of the out-

standing stock of the acquiring corporation,

the total net operating loss carryover from prior

taxable years of the loss corporation to the first taxable

year of the acquiring corporation ending after the date

of transfer shall be reduced by the percentage deter-

mined under paragraph (2).

‘**(2) Reduction of Net Operating Loss Carryover.—

The reduction applicable under paragraph (1) shall

be the percentage determined by subtracting from

10U percent—

‘‘(A) the percent of the fair market value of the

outstanding stock of the acquiring corporation

owned (immediately after the reorganization) by

— »

\

\

. 37a

the stockholders (immediately before the reorganiza-

tion) of the loss corporation, as the result of owning

stock of the loss corporation, multiplied by

**(B) five.

‘*(3) Exception to Limitation in this Subsection.—

The limitation in this subsection shall not apply if the

transferor corporation and the acquiring corporation

are owned substantially by the same persons in the

same proportion. .. .

‘*(6) Stock of Corporation Controlling Acquiring

Corporation.—If the stockholders of the loss corpora-

tion (immediately before the reorganization) own, as

a result of the reorganization, stock in a corporation

controlling the acquiring corporation, such stock of

the controlling corporation shall, for purposes of this

subsection, be treated as stock of the acquiring corpo-

ration in an amount valued at an equivalent fair market

value. i

‘“(c) Definition of Stock—For purposes of this

section, ‘stock’ means all shares except nonvoting

stock which is limited and preferred as to dividends.’?

Technical Information Release No. 773, By Commission

October 13, 1965.

The United States Internal Service today announced

that it will not follow the decision of the United States

Court of Appeals for the Ninth Circuit in the case of

Mazwell Hardware Co..v. Commissioner, 343 F.2d 713

(1965).

In that case, the circuit court held that the Supreme

Court’s decision in Libson Shops, Inc. v. Koehler, 353 U.S.

382 (1957), has no precedential value under the 1954 Code,

and that the net operating loss carryovers involved therein

were not subject to disallowance under section 172, 269 or

382. The court, by way of dictum, stated that the Com-

Pie NS aE

i a a

38a

misioner might have successfully applied section 482 in

this ease.

It is the position of the Revenue Service that in cases

similar to Maxwell Hardware, sections 269 and 382, as well

as section 482, are applicable in dealing with the carryover

of losses. The Revenue Service believes that the foregoing

statutory prov’sions must be construed to effectuate con-

gressional intent in combating ‘‘trafficking in loss carry-

overs.’’ Moreover, the Service also believes that the loss

carryover in cases similar to Maxwell Hardware should be

denied under the rationale of the Libson Shops decision

since to permit a loss carryover in such cases would run

counter to the legislative objectives of the carryover

privilege.

The cornerstone of the Libson Shops decision was a

searching examination of the purposes of the carryover

privilege. Thus, in approaching the question of whether

the taxpayer was entitled to a loss carryover, the Supreme

Court held that the loss carryover provision was not

automatic and that the ‘‘availability of . . . [the loss

carryover] privilege depends on the proper interpretation

to be given to the carryover provisions.’’ The Service

believes that this fundamental type of statutory analysis

was not made obsolete by the enactment in 1954 of pro-

visions limiting or denying loss carryovers in certain

situations involving abuses that were specifically brought

to the attention of Congress. It is the view of the Service

that the basic approach of the Supreme Court in Libson

Shops retains vitality under the 1954 Code in interpreting

the application of section 172.

Accordingly, the Service will apply Libson Shops in any

loss carryover case under the 1954 Code, not contemplated

by the announcement in Revenue Ruling 58-603, C.B.

1958-2, 147, where there has been both a 50 percent or

more shift in the benefits of a loss carryover (whether

direct or indirect and including transactions having the

7

39a wR)

effect of shifting the benefit of the loss by shifting assets,

stock, profit interests or gther valuable rights) and a

change in business as defined in section 382(a) and the

regulations thereunder. The Service will not rely on

Iibson Shops under the 1954 Code in any loss carryover

case where there has been less than a 50 percent change

in the beneficial ownership of the loss or where there has

been no change in business as defined in section 382 (a)

and the regulations thereunder. However, the Service will

continue to rely on sections 269 and 482, where appropriate,

in dealing with the carryover of losses. Revenue Ruling

63-40, C.B. 1963-1, 46 will be modified te the extent incon-

sistent herewith.

The Revenue Service stated that certiorari was not

requested in Maxwell Hardware due to the absence of a

direct conflict between the circuits. The decision will not

be followed as a precedent in the disposition of similar

cases.

(Copied from 1965 Commerce Clearing House Income Tax

Service, {| 6751)

Item 1—Extract from House and Senate Committee Reports

on § 172 of the 1954 Code:

‘‘A further substantive change will permit taxpayers

other than corporations who sell a business or certain

business assets in effect to include any loss sustained

on the sale of such business or business assets as part

of a net operating loss for the year of the sale (Cor-

porations are entitled to this treatment under present

law and under this section). Thus, subsection (d) (4)

(A) will overrule the decision in Joseph Sic. v. Com-

missioner (10 T.C. 1096, 177 F.2d 649 (CA-8),

certiorari denied, 339 U.S. 913, 70 S.Ct. 572), and

similar cases, which held, for example, that a farmer

who sold his farm at a loss could not include such loss

as part of his net operating loss. The cases indicated

SOT ey

AAO ty

Perrott

CRORE ETRE Mea ECAR aN

40a

that such loss was a nonbusiness loss since the tax-

payer was not in the business of selling farms. The

new provisions will reach the opposite result.’’

(U.S. Cong. & Admin. News 1954, pp. 4193, 48-49)

Item 2—Extract from House Committee Report on § 381 of

the 1954 Code:

““D. Carryover to successor corporations (sec. 381)

Present law makes no provision for the transfer from

one corporation to another in a tax-free merger or

consolidation, of the major tax benefits, privileges,

elective rights and obligations which were available to

the predecessor. These include such items as loss

carryover, unamortized bond discount, installment

sales reporting, LIFO inventory method, ete. The

courts have held, in general, that such tax attributes

of a corporation may be preserved only by continuing

the corporation’s identity. For example, the surviving

corporation in a merger is generally entitled only to

the tax attributed from its own premerger experience

and not from the experience of the other corporations

merged. More recently, however, this separate entity

rule appears not to have been followed.

‘*As a result, present practice rests on courtmade law

which is uncertain and frequently contradictory.

Moreover, whether or not the carryover is allowed

should be based upon economic realities rather than

upon such artificialities as the legal form of the re-

organization.

‘‘The new rules enable the successor corporation to step

into the ‘tax shoes’ of its predecessor corporation

without necessarily conforming to artificial legal re-

quirements which now exist under court-made law.

. .’ (U.S. Cong. & Admin. News 1954, pp. 4066-7,

emphasis supplied)

oe: > -—e

4la

Item 3(a) Extract from Senate Committee Report on § 122

of the Revenue Act of 1943 Respecting § 120 of the 1939 Code:

“The objective of the section, as stated in the report

on the House bill, is to prevent the distortion through

tax avoidance of the deduction, credit, or allowance

provisions of the Code, particularly those of the type

represented by the recently developed practice of cor-

porations with large excess profits (or the interests

controlling such corporations) acquiring co-porations

with current, past, or prospective losses or deductions,

deficits, or current or unused excess profits credits,

for the purpose of reducing income and excess prefits

taxes. (1944 Cum. Bul. 1016)

* 2 @ @

‘*Your committee recognizes these facts and is in agree-

ment with these objectives. Your committee also recog-

nizes the difficulty of formulating a proper general

provision which will be helpful in administration and

decision in distinguishing between business conduct

which effectuates the basic purposes of the deduction, |

credit, and allowance provisions of the Code and

arrangements which distort. pervert, and defeat such

basic purposes. (1944 Cum. Bul. 1016)

“*. . . To determine what transactions constitute the

condemned evasion or avoidance, section 129 must be

read in its context and background. It is super-

imposed on the several existing provisions of the

income and excess profits tax law, the basic policies

of which contemplate the bona fide conduct of business

in the ordinary way. Basic to the deduction, credit,

and allowance provisions is a continuing enterprise so

conducting its affairs. A substantial number of the

Code provisions, like sections 112, 113, and 141, are

especially designed to remove tax impediments from

such business transactions. It is nonconfirmity to the

basic policies of these provisions of the Code which is

42a

denoted by tax avoidance in section 129, and it is in the

light of these basic policies that section 129 would

necessarily have to be applied and administered. Such

is also the case under section 45 and under the

principles applied in the absence of the explicit

statutory language. The National securities and

Spreckles cases cited above aptly illustrate such non-

conformity, violating in those cases the basic policies

of the deduction provisions, and in the Spreckles case,

the consolidated returns provisions. ‘The test of this

nonconformity is, as was indicated in Higgins v. Smith,

whether the transaction or a particular factor thereof

‘distorts the liability of the particular taxpayer’ when

the ‘essential nature’ of thé transaction or factor is

examined in the light of the ‘legislative plan’ which

the deduction or credit is intended to effectuate.

(1944 Cum. Bul. 1017)

Item 3(b) Extract from Conference Report on the Revenue

Act of 1943 Respecting § 129 of the 1939 Code:

‘‘Under the conference agreement, the categories of tax

evasion and tax avoidance selected for specific treat-

ment under section 129 are those characterized either

by the acquisition of control of a corporation, or by

the acquisition of property (with a transferred basis)

by one corporation from another not controlled im-

mediately prior to such acquisition by such first

corporation. ...? (1944 CB 1069.)

Item 4 Extract from House and Senate Committee Reports

on the 1954 Code Respecting § 269(c):

‘¢., . This provision will apply to cases where the tax

basis of the property acquired for depreciation and

other purposes, together with the tax value of other

tax benefits, such as operating loss carryovers, is

substantially greater than the amount paid for the

property. Disparities of this type generally arise

where the old basis is continued in the hands of the

new owner.’”’ (U.S. Cong. & Admin. News 1954, pp.

4057, 4670, emphasis supplied)

43a

Certain Specific Organization Expenses of Consumers

In the following part of the stipulation in both Nos. 30,116

and 30,117, Cotisumers Company is called ‘‘Delaware”?

and its predecessor, an Illinois corporation, is called ‘TIli-

nois.’’ It was stipulated that during the period from June

19, 1934, until February 28, 1938, ‘Illinois and Delaware

incurred and paid the following organization and reorgani-

zation expenses to the persons or firms listed in respect of

the services described: .. .

*‘(m) Halsey, Stuart & i SiGe anced $14,592.90

‘The Court ordered Delaware to pay Halsey, Stuart &

Co., Ine. reasonable compensation for services rendered and

to be rendered as Exchange Agent in making the payments

of cash and effecting the exchange of securities of Delaware

as requird by the Substitute Plan of Reorganization and

the Court decree confirming said Plan.

‘‘(n) Continental Illinois National Bank ....... $10,029.45

‘‘Continental Illinois National Bank and Trust Company

of Chicago acted as the transfer agent of Delaware and of

the trustees of the stock trust created under the Substitute

Plan of Reorganization.

‘“/9) Chicago Stock Exchange ................. $3,000.00

‘‘The amount listed was paid to the Chicago Stock Ex-

change (predecessor to the Midwest Stock Exchange) by

Delaware during 1937 to cover listing fees for various

securities issued by the Company.

‘“(p) Secretary of State of Illinois .......... » - -$3,209,.34

‘*The amount listed was paid to the Secretary of State of

Illinois for for various services including fees for minis-

44a

terial and recording services required under applicable

state laws of Illinois.

‘*(q) Security Banknote Company .............. $3,564.25

‘‘(r) Security Banknote Company .............. $3,564.25

‘‘This amount was paid to Security Bank Note Company

by Illinois and Delaware for the printing of new certificates

evidencing ownership of securities issued by the reorgan-

ized company.”’

Evidence Respecting Erroneous Findings of Fact by the

Court of Appeals

In the discussion of the statutory provison that the

‘principle purpose”’ shall be ‘‘the evasion or avoidance of

Federal income tax,’’ the Court of Appeals concluded, in

effect, that there was no proof of association between the

sale of assets and the precise merger, and made other com-

ments about the absence of evidence which might have been

persuasive to show that tax avoidance was not the principle

purpose of the merger, pp. 16a-20a. There is a specific

statement that Follansbee had converted its assets to cash

at some point before the stockholders’ meeting, p. 18a.

That statement, and the foregoing implications of other

statements in the opinion, are plainly erroneous. This is

shown by the notice of the call of the special meeting of the

stockholders of Follansbee to be held ox October 27, 1954,

given by order of the Board of Directors dated October 4,

1954, and in the Proxy Statement attached thereto. The

items of business to be transacted were described in the

notice as follows:

‘1, ‘The adoption or rejection of’ a Purchase Contract

dated August 2, 1954, and amended September 22, 1954, of

a Sy Sees

45a

which a copy was attached as Exhibit A to the Proxy

Statement.

‘*2. ‘The adoption or rejection (subject to the adoption

of the Purchase Contract) of a certain Agreement of

Merger dated September 15, 1954,’ a copy of which was

attached as Exhibit B to the Proxy Statement. This agree-

ment provided for the merger of Consumers and Frontier

into Follansbee described on page 4 and for the change of

Follansbee’s name to Union Chemical. Parts of this

agreement are copied on p. 28a.

‘*3. Any other business that might properly come before

the meeting.’’ (Emphasis supplied)

It was stipulated that the contents of the Proxy State-

ment and other material should constitute evidence in No.

30,117 without further proof. The Proxy Statement con-

tains specific assertions that the merger was conditioned,

and dependent, upon consummation of the sale of the

Follansbee assets, pursuant to the Purchase Contract. No

specific relief is sought in this Court in reliance on these

additional facts. They are stated, primarily, to show that

the Court of Appeals proceeded upon an erroneous view

of the facts as to the relationship between the Purchase.

Contract and the merger, and that the decision is not neces-

sarily based on a question of fact.