Brief for the United States — Central Tablet Mfg. Co. v. United States

INDEX

3 ns POIOW

Question presented _ _ _ eee annee

Statute involved 5

Statement

Argument:

Introduction and summary

The gain realized by a corporation from

insurance proceeds arising out of the in-

voluntary conversion of its property by

fire does not qualify for nonrecognition

under Section 337 of the Code, where the

fire occurred prior to the corporation’s

adoption of a plan of complete liquidation

A. The judicial extensions of Section

337 to involuntary conversions from

destruction require that the plan of

liquidation precede the destructive

event

B. The destruction of petitioner’s prop-

erty by fire is analogous to the ini-

tial taking of property in an invol-

untary conversion by condemnation

C. The involuntary conversion as a re-

sult of a fire loss is not postponed

beyond the time of the fire even

though no transfer of ownership is

involved

Conclusion

13

13

17

20

26

Il

CITATIONS

Cases: Page

Boykin v. Commissioner, 344 F. 2d 889__. 23

Burnet v. Logan, 283 U.S. 404 24

Cluff v. Commissioner, 17 T.C. 225 24

Commissioner v. Baertschi, 412 F. 2d

494 _ ae 23

Commissioner v. Court Holding Co., 324

US. 331 _5, 6, 22

Commissioner v. Kieselbach, 127 F. 2d

359, affirmed, 317 U.S. 399. - 25

Covered Wagon, Inc. v. Commissioner,

369 F. 2d 629 18

Dwight v. United States, 328 F. 2d 973. 17, 18

Gralapp v. United States, 458 F. 2d 1158 24

Helvering v. Flaccus Leather Co., 313

US..247 a 8, 10

Hooper v. Commissioner, 26 B. T.A. 758 25

Kent Manufacturing Corp. v. Commis-

sioner, 288 F. 2d 812 9, 14, 15, 16

Kinney v. United States, 73-1 U.S.T.C.

7 9140, decided November 10, 1972

(N.D. Cal.) ___20, 21, 22

Likins-Foster Honolulu Corp. v. Commis-

sioner, 417 F. 2d 285, certiorari denied,

397 U.S. 987 18

Lucas v. North Texas Co., 281 US. 1. 23

McFeely v. Commissioner, 296 U.S. 102. 25

Marshall, Estate of v. Commissioner, 20

T.C. 979 24

Mountain Water Co. of Le Crescenta ° v.

Commissioner, 35 T.C. 418 - _

Rose v. United States, 229 F. Supp. 298

Cases—Continued Page

Steele v. United States, 52-2 U.S.T-C.

§ 9451, decided March 25, 1952 (S.D.

Fla.) 25

Towanda Textiles, Inc. v. United States,

180 F. Supp. 373 9, 14, 16

United States v. Cumberland Public Serv-

ice Co., 338 U.S. 451 . _5, 6, 22

United States v. Jones, 194 F. 2d 783 24

United States v. Morton, 387 F. 2d 441 10, 11,

20, 21, 22, 25, 26

Virginia Ice and Freezing Corp. v. Com-

missioner, 30 T.C. 1251 7

Wendell v. Commissioner, 326 F. 2d 600 18

Whitson v. Rockwood, 190 F. Supp. 478 7

Wiseman v. Scruggs, 281 F. 2d 900 __- 23

Statutes and regulations:

Internal Revenue Code of 1939 (26

U.S.C., 1952 ed.), Sec. 117(j) 8,14

Internal Revenue Code of 1954 (26

U.S.C.) :

Sec. 331(a) a 5

Sec. 337 _passim

Sec. 337(a) -2,3,7,9

Sec. 368(a) (1) (B) 24

Sec. 392 ; 9

Sec. 392(b) en 15

Sec. 1033 \ 13

Sec. 1222 . 25

Sec. 1231 \ 8,14

See. 6043 (a) \ 7,8

Se. 7208 8

lV

Statutes and regulations—Continued

Revenue Act of 1921, c. 136, 42 Stat.

yo Af

Sec. 214(a) (12) _......-------------------..

Sec. 234(a) (14)

Treasury Regulations on Income Tax (26

C.F.R.):

See. 1.887-1 a.

Miscellaneous:

Hearings before the House Ways and

Means Committee, on Advisory Group

Recommendations on Subchapters C, J,

and K of the Internal Revenue Code,

86th Cong., Ist Sess., pp. 478, 532...

H. Rep. No. 1337, 83d Cong., 2d Sess. _

I.T. 3287, 1939-1 Cum. Bull. (Part 1)

138 .

Rev. Rul. 56-372, 1956-2 Cum. Bull. 187.

Rev. Rul. 59-108, 1959-1 Cum. Bull. 72.

Rev. Rul. 64-100, 1964-1 Cum. Bull.

(Part 1) 130 -

Rev. Rul. 65-30, 1965-1 Cum. Bull. 155

Rev. Rul. 66-112, 1966-1 Cum. Bull. 68

Rev. Rul. 67-90, 1967-1 Cum. Bull. 79.

S. Rep. No. 1622, 83d Cong., 2d Sess. .

In the Supreme Court of the United States

OCTOBER TERM, 1973

No. 73-593

CENTRAL TABLET MANUFACTURING CO., PETITIONER

Vv.

UNITED STATES OF AMERICA

ON WRIT OF CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE SIXTH CIRCUIT

BRIEF FOR THE UNITED STATES

OPINIONS BELOW

The opinion of the district court (Pet. App. A 11-

21)’ is reported at 339 F. Supp. 1134. The opinion

of the court of appeals (Pet. App. B 22-80) is re

ported at 481 F. 2d 954.

*“Pet. App.” refers to the appendix to the petition for a

writ of certiorari; “A.” references are to the separately bound

record appendix.

(1)

2

JURISDICTION

The judgment of the court of appeals was entered

on August 7, 1973 (Pet. App. C 31). The petition

for a writ of certiorari was filed on October 3, 1973,

and was granted on December 17, 1973 (A. 58). The

jurisdiction of this Court rests on 28 U.S.C. 1254(1). |

QUESTION PRESENTED |

Whether the gain realized by a corporation from

_ insurance proceeds arising out of the involuntary cor-

version of its property by fire qualifies for nonrecog-

nition under Section 337 of the Internal. Revenue

_ Code, where the fire occurred prior to the corpora-

tion’s adoption of a plan of complete liquidation.

STATUTE INVOLVED

Section 337(a) of the Internal Revenue Code of

1954 is set forth at page 2 of petitioner’s brief.

STATEMENT

Petitioner was in the business of manufacturing

and selling educational and art supplies. On Sep

tember 10, 1965, an accidental fire largely destroyed

its equipment and building, none of which was sub

sequently repaired or replaced. The building -and

equipment were covered by fire and extended cover-

age insurance (Pet. App. A 11-12; Pet. App. B 23;

A. 32).

The insurance company did not question either the

validity of the insurance contracts or the fulfillment

3

of the conditions for payment. It did, however, dis-

pute the exact amount to be paid under each policy.’

Negotiation of the claims for the building and equip-

ment began on or about November 1, 1965.

On May 14, 1966, petitioner’s shareholders adopted

a plan of complete liquidation and dissolution pursu-

ant to Section 337 of the Internal Revenue Code of

1954. Six days later, petitioner accepted a settle-

ment of its building insurance claim of $174,595.05,

which was paid on June 15, 1966. On August 25,

1966, petitioner accepted a settlement of its personal

property insurance claim of $104,609.27, which was

paid to it on November 17, 1966 (Pet. App. A 12-

13; Pet. App. B 24; A. 33-34).

Petitioner realized a gain upon the transaction be-

cause the amount of the insurance proceeds was great-

er than its adjusted bases in the various items of

property destroyed. However, it excluded such gain

from its taxable income under Section 337(a) of the

Code (A. 35). Under that provision, no gain or loss

is recognized by a corporation from the sale or ex-

change of its property within 12 months from the

adoption of a plan of complete liquidation if all of

its assets are distributed in liquidation within such

12-month period.

*The insurer asserted the applicability of a co-insurance

clause in the building insurance policy, and questioned the

extent of the building loss, the value of the building at the

time of loss, the value of the machinery and equipment that

was lost or damaged, and the cost of repair of repairable ma-

chinery and equipment (Pet. App. A 12; Pet. App. B 23; A.

33).

4

On audit, the Commissioner of Internal Revenue de-

termined that the nonrecognition provisions of Sec.

tion 337 did not apply because the conversion of the

property was at the time of its destruction by fire,

which occurred prior to petitioner’s adoption of a plan

of complete liquidation (A. 34-35). The district court

upheld petitioner’s claim for refund on the ground

that the relevant date for purposes of Section 337 was

either the date that the insurance proceeds were re-

ceived or when an enforceable settlement of a deter-

mined amount was reached, both of which occurred

after the adoption of the liquidation plan (Pet. App.

A 13-19). The court of appeals, however, unani-

mously reversed, holding that the critical date for

purposes of Section 337 was when the fire occurred.

It refused to construe the statute to permit nonrec-

ognition of gain when property is destroyed before

adoption of a plan of liquidation (Pet. App. B 25-30).

ARGUMENT

INTRODUCTION AND SUMMARY

1. Prior to the enactment of Section 337 of the

Internal Revenue Code in 1954, it was not clear under

what circumstances a corporation in the process of

complete liquidation would be deemed to have made a

sale of its property and when its shareholders would

be viewed as having made the sale. Resolution of

this question was important because this common type

of transaction had different tax consequences depend-

ing upon the identity of the seller of the corporate

5

property. If the corporation made the sale, it would

be taxable on the gain, and if the amount of the liqui-

dating distributions exceeded the shareholders’ bases

in their stock, another tax would be imposed upon

the shareholders. See Internal Revenue Code, Sec-

tion 331(a)(1). If, however, the corporate property

was first distributed in liquidation and the share-

holders thereafter sold it, they would be taxed upon

the difference between the value of the property and

the bases of their stock but no gain would be tax-

able to the corporation.

Although it would appear that the identity of the

seller in these circumstances would be a relatively

simple matter to determine, two decisions of this

Court made certainty in a corporate liquidation some-

what more difficult to achieve. In Commissioner Vv.

Court Holding Co., 324 U.S. 331, the Court held that

the liquidating corporation made the sale even though

the corporate assets were previously distributed to

the shareholders and they were named as the sellers

in the contract of sale. The critical fact, in the

Court’s view, was that the negotiations for the sale

of the property were conducted by the corporation

prior to the distribution of its assets to the share-

holders. Conversely, in United States v. Cumberland

Public Service Co., 338 U.S. 451, the shareholders

had first attempted to sell the stock of their corpora-

tion, but when the buyer refused to buy the stock, they

offered to acquire the assets by liquidating the cor-

poration and then to sell the assets. On these facts,

the Court affirmed the Court of Claims’ finding that

6

the shareholders and not the corporation had sold

the assets.

After the Court Holding and Cumberland Public

Service Co. decisions, it was no longer clear how

shareholders might accomplish a sale of the property

of their corporation so as to eliminate’ taxable gain

to the corporation. As a result, the Senate Finance

Committee at the time of the 1954 codification of the

tax law observed that “[t]he result of these two de-

cisions is that undue weight is accorded the formal-

ities of the transaction and they, therefore, repre-

sent merely a trap for the unwary.” S. Rep. No.

1622, 83rd Cong., 2d Sess., pp. 48-49. See also H.

Rep. No. 1337, 83d Cong., 2d Sess., pp. 38-39. In

response to this problem, Section 337 was enacted

“to provide a definitive rule which [would] eliminate

the present uncertainties.” S. Rep. No. 1622, supra,

p. 258. It provides that if a corporation adopts a

plan of complete liquidation and disposes of all its

assets and liquidates within 12 months after the

adoption of the plan, no gain or loss shall be recog-

nized by the corporation from the sale or exchange

by it of property within the 12-month period.

By its terms, the statute becomes operative only

if the corporation “adopts a plan of complete liquida-

tion” and distributes all of its assets in complete liqui-

dation “within the 12-month period beginning on the

date of the adoption of such plan.” If these require-

ments are met, then the corporation does not recog-

nize any gain or loss “from the sale or exchange by

it of property within such 12-month period.” A sale

7

or exchange can occur “within” the 12-month period

only if it occurs subsequent to the adoption of the

plan. Indeed, the only exception to this strict stat-

utory rule is a minor one in the Regulations for

sales made “before the adoption of the plan of liqui-

dation if made on the same day such plan is adopted.”

Treasury Regulations, Section 1.337-1.

As a result of this rigid statutory requirement that

sales occur within the 12-month period, in Virginia

Ice & Freezing Corp. v. Commissioner, 30 T.C. 1251,

the Tax Court, on finding that the taxpayer’s sale of

property was prior to the adoption of a plan of com-

plete liquidation, held that the sale could not come

within the nonrecognition provisions of Section 337

(a). See also Whitson v. Rockwood, 190 F. Supp.

478 (N. Dak.). Indeed, the paucity of cases on this

point demonstrates that the statutory requirement is

well understood to be absolute.

Under no circumstances, therefore, can Section 337

be construed to permit retroactive application of a

plan of liquidation to cover the gain from a prior

sale. Enforcement of the statutory requirement is

enhanced by Section 6043(a) and Treasury Regula-

tions, Section 1.337-6. Pursuant to those provisions, »

a corporation within 30 days of its adoption of a plan

of liquidation must file with the Internal Revenue

Service a copy of the plan, a statement of assets sold

after the adoption of the plan and the dates of such

sales, and information concerning the date of the

final liquidating distribution. Receipt of such infor-

mation by the Internal Revenue Service thereby re-

8

duces the likelihood that a taxpayer will claim that

a plan was adopted earlier than it was in fact adopted

in order to obtain nonrecognition treatment for the

gain from a prior sale.*

2. In Helvering v. Flaccus Leather Co., 313

U.S. 247, this Court held that a sum received by a

taxpayer as proceeds of insurance on buildings and

equipment destroyed by fire was not a gain from the

“sale or exchange” of capital assets. In the Court’s

analysis, the destruction of property and the payment

by an insurance company for its loss was simply a

single transfer to compensate the owner. Such a

transaction did not contain the reciprocal transfers

which are necessary to show a sale or exchange. As

a result of this decision, the Internal Revenue Service

initially took the position that the involuntary con-

version of property by fire and the subsequent receipt

of insurance proceeds was not a “sale or exchange”

within the meaning of Section 337. Rev. Rul. 56-372,

1956-2 Cum. Bull. 187.

The holding in Flaccus Leather Co. was changed

by the enactment of Section 117(j) of the Internal

’The Internal Revenue Service has ruled that failure to

file the information return required by Section 6043 or the

information required by Treasury Regulations, Section 1.337-6,

will not automatically enter Seat ee 337 treat-

ment:. The ruling states, however, that a failu do so may

subject the taxpayer to the provisions of Section 7203 of the

Code, which impose criminal] penalties for willfull failure to

supply information required by the Regulations. See Rev. Rul.

65-30, 1965-1 Cum. Bull. 155. Moreover, the failure to file

this information may cause the Service to question whether

or when a plan was adopted. y

9

Revenue Code of 1939 (now Section 1231 of the 1954

Code), which permitted capital gains treatment for

the net gains from involuntary conversions to the

same extent as if they had been realized in sales or

exchanges. On the basis of this amendment of one

Code provision dealing with gains-from involuntary

conversions, two court decisions rejetted the Service’s

ruling position that such gains were not from sales

or exchanges for purposes of Section 337. These de-

cisions indicated, however, that nonrecognition under

such circumstances was permitted only where the de-

struction occurred subsequent to the adoption of a

plan of liquidation. See Towanda Textiles, Ine. V.

United States, 180 F. Supp. 373 (Ct. Cl.); Kent

Manufacturing Corp. v. Commissioner, 288 F. 2d 812

(C.A. 4).*

In this limited sense, therefore, the scope of the

statute was extended to encompass involuntary con-

versions as a result of fire or other destruction.

In response to these adverse decisions, the Internal

Revenue Service subsequently modified its position

and treated an involuntary conversion resulting from

the destruction of corporate property occurring after

the adoption of a plan of liquidation as if it were a

“sale or exchange” for purposes of Section 337(a).

See Rev. Rul. 64-100, 1964-1 Cum. Bull. (Part 1)

130.

‘As we discuss infra, pp. 15-16, Kent Manufacturing in-

volved a claim under Section 392 of the Code, a transition

provision with respect to sales of property by a liquidating

corporation during 1954.

10

3. The issue in this case involves the application of

the strict statutory requirement that the adoption of

the plan of liquidation precede the sale or exchange.

It arises in the context of the involuntary conversion

of insured property as a result of its destruction by

fire prior to the adoption of the plan of liquidation.

Subsequent to the fire, petitioner adopted a plan of

liquidation. It seeks the benefits of the nonrecogni-

tion provisions of Section 337 on the ground that the

agreement as to the amount of the insurance proceeds

and the payment of its claim occurred after the adop-

tion of the plan. The court of appeals, however, cor-

rectly held that the involuntary conversion of peti-

tioner’s property occurred upon its destruction by

fire and not upon the subsequent agreement or the

payment of the claim. * Since the fire preceded the

adoption of the liquidation plan, Section 337 was

. held to be inapplicable.“ In so concluding, the deci-

sion below rejected the reasoning of the Eighth Cir-

cuit in United States v. Morton, 387 F. 2d 441.

Although such an involuntary conversion is now

treated as if it were a “sale or exchange” for pur-

poses of Section 337, it is plain, as this Court held in

Helvering v. Flaccus eather Co., supra, that it is not

identical to a sale or exchange. Nevertheless, the

>There is no question that the liquidation was completed

within the 12-month period. On May 3, 1967, the remaining

assets, after liquidating distributions to the shareholders,

were transferred to a national bank as trustee to meet claims

against petitioner. On the same date, petitioner was dissolved

under Ohio law (Pet. App. A 13; Pet. App. B 24; A. 34).

11

judicial extension of Section 337 to this type of in-

voluntary conversion requires that analogies be drawn

to other transactions where a transfer of ownership

occurs.

An involuntary conversion arising out of a con-

demnation offers the closest analogy. With respect

to such condemnations, the appellate courts, includ-

ing the Eighth Circuit, have uniformly held that the

involuntary “sale” for purposes of Section 337 occurs

upon the initial taking of the property and not upon

either the reaching of an agreement as to the amount

of the condemnation award or its ultimate payment.

The courts have so concluded even though a taking

of property by condemnation, like the fire in this

case, can occur without warning so.as to prevent the

timely adoption of a liquidation plan. Thus, as the

decision below observed, to permit nonrecognition

treatment where the destruction preceded the adop-

tion of a plan would accord petitioner the advantage

of hindsight unavailable in either an involuntary

conversion by condemnation or in the usual type of

sale or exchange.

There is no basis for the Eighth Circuit’s decision

in Morton that the involuntary “sale” arising out of

the destruction of property occurs when the amount

of the insurance proceeds is either agreed upon or

paid. Unlike the moment of destruction, which can

be easily ascertained, the subjective nature of the

determination of when an agreement is reached would

reintroduce the uncertainty in the corporate liquida-

—

12

tion process which the enactment of Section 337 was

intended to eliminate.

To the extent an analogy can be drawn to the usual

type of sale, both the destruction of property here

and the usual type of transfer by sale operate to

terminate the ownership relation with respect to

property. Moreover, it is well established that a sale

can occur for tax purposes long before the amount

of the consideration can be ascertained. There is

accordingly no justification for postponing the “sale”

for purposes of the statute to the point at which the

amount of insurance compensation is determined.

Finally, petitioner’s position is in conflict with the

undisputed rule that a taxpayer’s holding period of

property is coterminous with his ownership rights

and that both terminate upon the destruction of the

property. If, as petitioner contends, the relevant date

for purposes of Section 337 was when agreement

was reached regarding the amount of insurance to

be paid, the questionable conclusion follows that the

“sale” occurred long after the termination of peti-

tioner’s holding period and ownership. The operative

event, therefore, necessarily must be the fire.

13

THE GAIN REALIZED BY A CORPORATION FROM

INSURANCE PROCEEDS ARISING OUT OF THE

INVOLUNTARY CONVERSION OF ITS PROPERTY

BY FIRE DOES NOT QUALIFY FOR NONRECOG-

NITION UNDER SECTION 337 OF THE CODE,

WHERE THE FIRE OCCURRED PRIOR TO THE

CORPORATION’S ADOPTION OF A PLAN OF

COMPLETE LIQUIDATION

A. The judicial extensions of Section 337 to involuntary

conversions from destruction require that the plan

of liquidation precede the destructive event

In enacting Section 337 to eliminate the need to

identify the seller of corporate property in the course

of a complete liquidation, it seems fair to conclude

that Congress did not speak to the question whether

gains from involuntary conversions were to be eligi-

ble for nonrecognition treatment. But Congress was

surely aware of the general tax problems caused by

involuntary conversions, for, as early as the Revenue

Act of 1921,° the taxing statutes had provided for

nonrecognition of gain from involuntary conversions

where the property was replaced within a specific

period of time. Because there is no reference to in-

voluntary conversions by destruction in either the

terms of Section 337 or in its legislative history

which would support their inclusion into the statu-

tory term “sale or exchange,” there was certainly a

* See Revenue Act of 1921, c. 136, 42 Stat. 227, Sections 214

(a)(12) and 234(14), relating to individuals and corpora-

tions respectively. Although there have been changes in the

statute with respect to the specific requirements for qualifica-

tion, the basic nonrecognition principle survives in Section

1033 of the present Code.

14

persuasive case that Section 337 was not meant t

apply in such circumstances. Nevertheless, the court

reasoned that Congress would not have excluded in

voluntary conversions arising from the destructim

of insured property had it addressed the problem,

and the Service announced its acceptance of they

holdings.’

In so concluding, however, both the Court of Claims

in Towanda Textiles, Inc. v. United States, supm,

180 F. Supp. 373, and the Fourth Circuit in Kent

Manufacturing Corp. v. Commissioner, supra, 288 F.

2d 812, indicated that Section 337 required the adop

tion of the plan of liquidation to precede the destruc

tion of the property. Thus, in Towanda Textiles

where the fire occurred three days after the ado

tion of the plan, the court stated that “It is not con

ceivable that Congress would have drawn a distine

tion between a gain from a voluntary conversion and

an involuntary one, had the possibility of an invdl-

untary conversion during liquidation come to its at

tention” (180 F. Supp. at 376) (emphasis supplied).

The court’s reference to a conversion “during” liqui-

dation, coupled with the fact that the plan in that

™The rationale of the decisions was grounded solely

Section 117(j) of the 1939 Code (now Section 1231 of th

1954 Code), providing that net gains from involuntary co

versions of property used in trade or business shall be cor

sidered as gains from sales or exchanges of capital assets held

for more than six months. While relying on this statute, the

Court of Claims in Towanda Teztiles nevertheless acknow:

edged that “Literally, an involuntary conversion is not a sak

* * *” (180 F. Supp. at 376).

15

case was adopted prior to the fire, necessarily sug-

gests its agreement with the proposition that the de-

struction of the property must occur after the com-

mencement of the liquidation process, which can only

be manifested by the adoption of a liquidation plan.

Similarly, the Fourth Circuit in Kent Manufactur-

ing Corp. indicated that Section 337 requires that the

liquidation plan precede the destruction of the prop-

erty. There, both the destruction of the property and

the payment of the insurance claim preceded the

adoption of the liquidation plan. Although the court

sustained the taxpayer’s claim to nonrecognition

treatment, it did so only because the transaction

qualified under Section 392(b). That provision was

enacted together with Section 337 in the 1954 Code

to provide a transition from the 1939 Code, which

contained no rule comparable to Section 337. Under

Section 392(b), a liquidating corporation which made

sales of its property during 1954 before the passage

of Section 337 could elect nonrecognition treatment

for the gain on such sales as long as it distributed

all of its assets in complete liquidation before Janu-

ary 1, 1955. Significantly, however, the court spe-

cifically agreed with the Commissioner that Section

337 did not apply to the transaction “because the

conversion did not occur and the gain was not real-

ized in the course of a previously planned liquida-

tion” (emphasis supplied) (288 F. 2d at 816).

By distinguishing between the initial “conversion”

(destruction) of the property and the subsequent

realization of gain (receipt of the insurance pro-

16

ceeds), and stating that both events must occur afte

the adoption of the plan, Kent Manufacturing cor.

rectly recognized, as the decision below held, that

Section 337 applies only when the adoption of tk

liquidation plan precedes the destruction of the prop

perty. If, as in this case, the sequence of events hai

been the destruction, the adoption of the plan, an

then the receipt of the insurance funds, the Fourth

Circuit would not have regarded the fact that th

insurance proceeds were received after the adoption

of the plan as sufficient to invoke the application of

the statute.

We submit that these observations by the very de

cisions which extended Section 337 to cover involur

tary conversions. by destruction correctly interpre

the statutory terms to exclude the case where, a

here, the destruction precedes the plan of liquid

tion. The holding of the Court of Claims in Towand

Textiles can perhaps be most easily explained on the

basis of equality of treatment for all corporate gaim

and losses from property arising after the adoption

of the plan of liquidation. If a corporation adopts.

liquidation pla, and thereafter its property is de

stroyed before if has an opportunity to dispose of it

by sale or exchange, it is arguably harsh to withhold

the benefits of nonrecognition.

But this rationale has no application to this case,

where allowance of nonrecognition would accord pref-

erential treatment for conversions by destruction

curring prior to the adoption of the liquidation plan

over the usual type of sale or exchange which mus

17

take place after the adoption of the plan. As the

court of appeals correctly observed (Pet. App. B 30):

“To expand the statute further by construing it to

permit nonrecognition when the property is destroyed

before adoption of a plan of liquidation would, in-

stead of preventing injustice to a taxpayer that had

decided to liquidate, give it an advantage over other

taxpayers by permitting it to decide after destruc-

tion of the property whether to rebuild with insur-

ance proceeds or to liquidate.”

B. The destruction of petitioner's property by fire is

analogous to the initial taking of property in an in-

voluntary conversion by condemnation

As we have noted, the payment by an insurance

company of a claim in connection with the destruc-

tion of property represents a unique category of in-

voluntary conversion for purposes of Section 337 in-

sofar as it does not involve any transfer of owner-

ship. To the extent that analogies can be drawn,

however, there are close parallels between this case

and an involuntary conversion by condemnation

where a transfer of ownership does occur. A casualty

involves a sudden event, as can a condemnation (see,

e.g., Dwight v. United States, 328 F. 2d 973 (C.A.

2)), and both events create a claim for compensation

by the owner of the property against either an insur-

ance company or the condemning governmental au-

thority. In both cases, the event can occur without

prior warning and before the corporation is able to

adopt a plan of complete liquidation.

18

Despite the inability of the taxpayer to act quick)

under such circumstances, the courts of appeals, in

cluding the Eighth Circuit, have uniformly held tha

a corporation is not entitled to the benefits of Sectim

337 when the condemnation occurs prior to the adop

tion of the plan. See, e.g., Wendell v. Commissioner,

326 F. 2d 600 (C.A. 2); Dwight v. United States

supra; Covered Wagon, Inc. v. Commissioner, 369 f.

2d 629 (C.A. 8); Likins-Foster Honolulu Corp. x,

Commissioner, 417 F. 2d 285, 290 (C.A. 10), certio

rari denied, 397 U.S. 987. Thus, for example, iJ

Dwight v. United States, supra, the Second Circuit

held that the gain was realized upon the condemn:

tion of the property and not when the award wa

ultimately paid. Recognizing that “the corporation

had no opportunity to adopt a plan of liquidation be

fore condemnation, and [that] the conditions of sec

tion 337 could not be met,” the court observed that

“(tjhis may appear a harsh result, but if it is tok

corrected Congress must act; the courts have w

power to do so” (328 F. 2d at 974).*

Significantly, in all of the decisions involving i-

voluntary conversions by condemnation, the operative

“sale or exchange” for purposes of Section 337 wa

*In 1959, Congress was urged to provide an /exception t

the absolute statutory requirement by extending Section 33

to cover all types of involuntary conversions occurring pria

to the adoption of a liquidation plan, but it never acted on the

proposal. See Hearings before the House Ways and Mean

Committee, on Advisory Group Recommendations on Sw

chapters C, J and K of the Internal Revenue Code, 86th Cong,

1st Sess., pp. 473, 532.

19

uniformly held to have occurred when the incidents

of ownership of the property passed from the tax-

payer to the condemning authority. Contrary to the

statement of the district court in Kinney v. United

States, 73-1 U.S.T.C. {9140 (decided November 10,

1972 (N.D. Cal.), on appeal to the Court of Appeals

for the Ninth Circuit), upon which petitioner relies

(Br. 11), the condemnation decisions so held even

though the amounts of compensation the taxpayers

were to receive had not yet been determined.’ Thus,

just as the “sale or exchange” in the condemnation

cases arose upon the taking of the property and did

not depend upon the ultimate agreement as to the

award or its payment, so did the judicially-created

“sale or exchange” of petitioner’s property occur

upon its destruction and not when the amount of the

* Condemnation statutes differ. While some require that the

amount of compensation be fixed before the condemning au-

thority has the right to take the property, others provide that

the filing of a notice of taking transfers ownership to the

condemning authority. For purposes of Section 337, however,

the consistent rule is that the conversion occurs when the tax-

payer is required by local law to part with the incidents of

ownership in the property and receive in substitution a right

to compensation, regardless of whether or not the precise

amount of compensation has been determined at that time. See

Rev. Rul. 59-108, 1959-1 Cum. Bull. 72.

Cf. Mountain Water Co. of La Crescenta v. Commissioner,

35 T.C. 418, acquiescence, 1961-1 Cum. Bull. 4. There, the

transfer of the property to the condemning authority did

not occur under the local procedure until the taxpayer agreed

to accept the amount of a court-determined award. The Tax

Court found as a fact that at that point in time a plan of

liquidation had been adopted.

20

insurance claim was subsequently agreed upon ¢

paid.

For purposes of Section 337, there is no differeng

between a corporation which has parted with th

incidents of ownership of its property as a result ¢

a taking by condemnation and one which has suf.

fered the destruction of property covered by insu.

ance. In both cases, the corporation’s prior relation

ship to the property has been irrevocably terminated

and transformed into a claim for compensation. Up

less such a transformation occurs subsequent to th

adoption of the liquidation plan, the nonrecognitia

provisions of Section 337 are inapplicable.

C. The involuntary conversion as a result of a fire les

is not postponed beyond the time of the fire eva

though no transfer of ownership is involved.

In contending that the date of the involuntary co

version of its destroyed property was subsequent to

the adoption of a liquidation plan, petitioner relie

principally (Br. 8-12) upon the decision of the Eighth

Circuit in United States v. Morton, 387 F. 2d 441

and of the district court in Kinney v. United Stata,

73-1 U.S.T.C. $9140 (decided November 10, 197

(N.D. Cal.), on appeal to the Court of Appeals fo

the Ninth Circuit). Petitioner however, appears w

able to settle upon any one particular event in th

sequence from destruction to ultimate payment d

the claim. Thus, for example, it first contends (Br.

9) that the conversion occurs when a formula &

established for the measurement of the insured los

It next urges (Br. 10) that the conversion arise

21

when the insurer accepts the proof of loss. Finally,

it proposes yet another theory (Br. 10), that the

relevant event is the payment of the insurance claim.

Such uncertainty on the part of petitioner is hard-

ly surprising in view of the divergence of approach

between the Morton and Kinney decisions themselves.

In Morton, the court held that “[s]ince no title is

involved in a fire loss case of this type, we think the

catastrophe is but the commencement of an involun-

tary conversion that does not come into fruition until,

at least, the amount to be received by way of reim-

bursement for that loss is decided either by agree-

ment or by court action” (387 F. 2d at 447). In

marked contrast, however, the district court in

Kinney concluded that “under the insurance policy

until the proof of loss had been submitted and ac-

cepted by the insuror, there was no legally enforce-

able right to the proceeds accruing to the taxpayer”

(78-1 U.S.T.C. at 80,131).”

The applicability of Section 337, a provision de-

signed to bring objective certainty into the corporate

liquidation process, should not turn upon the subjec-

tive inquiry required by Morton as to when an agree-

* Unlike Morton where the agreement respecting the

amount of insurance payable was reached after the adoption

of the plan, such an agreement was reached in Kinney prior

to the plan of liquidation (73-1 U-.S.T.C. at 80,128). Thus, the

court in Kinney could not have held for the taxpayer had it

strictly followed the Morton rationale. It viewed the filing of

the proof of loss with the insurer, which occurred subsequently

to the adoption of the plan, as the pertinent event under

Section 337.

22

ment respecting compensation is reached between th

taxpayer and the insurer. Unlike the time of th

casualty, which is, for the most part, easily and }

jectively ascertained, there is great potential for dis

agreement among triers of fact in applying the Mor.

ton standard." Indeed, Section 337 was enacted ty

eliminate the confusion caused by disagreement

among finders of fact. Compare United States v. Cun.

berland-Public Service Co., 338 U.S. 451, 454, n. 3

with Commissioner v. Court Holding Co., 324 US

331. The Morton standard would reintroduce th

same type of uncertainty which existed prior to 195

with respect to conversions arising from casualties”

% The inquiry required by the district court in Kinney a

to when the proof of loss is “submitted and accepted” is simi-

larly subjective in nature.

12 Since Section 337 precludes the recognition of losses after

the adoption of a liquidation plan, the uncertainty of wha

an “agreement” is reached under the Morton rationale could

well work a hardship upon taxpayers. For example, suppose

a corporation suffers a loss of a major asset with a basis d

$100,000. Although it is uncertain as to the amount the ir

surer will pay, it submits a claim for $200,000. After cm

siderable discussion, however, the insurance company “

to pay $25,000 in compensation. If the corporation th

decides to liquidate and wishes to obtain Section 337 treatment

with respect to other assets it can sell at a gain, it is unclear

at what point it should adopt the plan of liquidation. It canned

adopt the plan before it ascertains whether the insurance pr-

_ ceeds will produce gain or a loss. To do so will preclude recog-

nition of the possible loss. Similarly, it cannot wait to adopt

the plan until after the amount of insurance is ascertained

without risking the possibility of having to recognize a po

sible gain if the insurer pays the entire claim. By fixing th

casualty as the “sale” for Section 387 purposes, the decisia

23

Moreover, the Morton rule would create a differ-

ence in treatment between involuntary conversions by

condemnation and those arising by casualty. In the

Eighth Circuit’s view, such a difference is justified

because a condemnation involves a transfer of own-

ership while a casualty does not. But this, we sub-

mit, is a distinction without a difference for pur-

poses of Section 337.

The fact that the statutory term “sale or exchange”

has been extended by the courts to encompass invol-

untary conversions resulting from destruction of

property requires the selection of the single event

which most closely corresponds to the point at which

a sale or exchange occurs, viz., when the benefits and

burdens of ownership are transferred so-as to termi-

nate the seller’s relationship to the property. See

e.g., Lucas v. North Texas Co., 281 U.S. 11; Boykin

vy. Commissioner, 344 F. 2d 889 (C.A. 5); Wiseman

v. Scruggs, 281 F. 2d 900 (C.A. 10); Commissioner

v. Baertschi, 412 F. 2d 494 (C.A. 6). The destruc-

tion by fire of petitioner’s property ‘erminated the

relationship it maintained with respect to the prop-

erty just as if it had transferred the incidents of own-

ership by sale or condemnation. In all cases, con-

tinued use by the owner is no longer possible.

_ Petitioner, however, argues (Br. 10) that the agree-

ment as to the amount of the insurance -proceeds is

the point at which the “sale” occurs because the usu-

below provides a uniform rule of certainty which allows the

recognition of losses under such circumstances and requires

the recognition of gains.

24

al type of sale does not arise until the price is deter.

mined. This analogy is unsound because it confusg

the concept of a sale with the realization of gain g

loss from a sale.

There are many situations where the amount of the

sales price is subject to future contingencies so that

the precise amount of gain or loss cannot be ascer.

taied at the time of transfer of ownership. Despite

this fact, a sale has nevertheless occurred for tar

purposes. See, e.g., Burnet v. Logan, 283 U.S. 404;

Gralapp v. United States, 458 F. 2d 1158 (C.A. 10);

United States v. Jones, 194 F. 2d 783 (C.A. 10);

Estate of Marshall v. Commissioner, 20 T.C. 979;

and Cluff v. Commissioner, 17 T.C. 225." Thus, th

computation of the sales price after the contingencies

have occurred is wholly separate and apart from the

sale itself.

Similarly, here, the occurrence of the fire created

an unconditional obligation by the insurer to pay com-

pensation in accordance with the contract of insur

«ance. The subsequent agreement as to the amount of

the compensation is simply an application of the

policy provisions to the specific facts of the case. I

13 By way of further illustration, it is quite common for one

corporation to acquire the stock of another corporation in ex-

change for a fixed number of shares of the acquiring corpo

ration’s stock plus a contingent number of shares based

upon either the future market price of the shares or up

the future earnings of the acquiredcorporation. The Service

has ruled that such transactions are-exchanges which are not

taxable under Section 368(a) (1) (B). See Rev. Rul. 66-112,

1966-1 Cum. Bull. 68; Rev. Rul. 67-90, 1967-1 Cum. Bull. 79.

25

that sense, it is analogous to the computation of a

sales price under a contigency formula.”

Finally, petitioner’s position and that of the

Eighth Circuit in Morton is inconsistent with the

rules governing the holding. period of property for

purposes of measuring whether the gain from the

sale of a capital asset is taxable as short-term or

long-term capital gain. See Section 1222 of the Code.

In McFeely v. Commissioner, 296 U.S. 102, 107, this

Court ruled that a taxpayer’s holding period with

respect to property was coterminous with the period

of his ownership.“ It was subsequently held with

respect to a condemnation that the taxpayer’s hold-

ing period ends with the transfer of ownership to the

condemning authority. Commissioner v. Kieselbach,

127 F. 2d 359, 363 (C.A. 3), affirmed on another

issue, 317 U.S. 399.

Similarly, in the case of a conversion by destruc-

tion, the taxpayer’s holding period ends with the de-

struction. Steele v. United States, 52-2 U.S.T.C.

§ 9451, decided March 25, 1952 (S.D. Fla.) ; Rose v.

United States, 229 F. Supp. 298, 300 (S.D. Cal.).

In those cases, involving sunken ships, the courts

rejected the taxpayers’ attempts, similar to that of

“ Petitioner further contends (Br. 10) that the fire is com-

parable to an executory contract of sale which is executed

only when the amount of insurance is payable. But in an ex-

ecutory contract, the position of the parties may be restored to

status quo ante. This is not possible, however, where the prop-

erty has been destroyed.

% See also Hooper v. Commissioner, 26 B.T.A. 758, and I.T.

3287, 1939-1 Cum. Bull. (Part 1) 138.

26

petitioner, to postpone the dispositive event beyond

the casualty to the time when they abandoned th

property and were compensated by the insurer. I

light of these holdings, the correctness of which ar

not in dispute, petitioner’s position is reduced tp

the questionable proposition that the “sale” of its

property for purposes of Section 337 took place long

after its ownership and holding period had ended

The “sale,” therefore, must be deemed to have o

curred at the time petitioner’s property was de

stroyed by fire.

%* The Eighth Circuit in Morton acknowledged that thes

cases are “sound as it would be difficult to hold a capital #

set after its destruction * * *.” It noted, however, that the

“appear to be of limited relevance in determining when a sak

or exchange has taken place in the event of an involuntay

conversion of a capital asset through destruction” (387 F2

at 446).

27

CONCLUSION

For the reasons stated, the judgment of the court

of appeals should be affirmed.

Respectfully submitted.

ROBERT H. Bork,

Solicitor General.

Scott P. CRAMPTON,

Assistant Attorney General.

STUART A. SMITH,

Assistant to the Solicitor

General.

WILLIAM A. FRIEDLANDER,

DavID ENGLISH CARMACK,

Attorneys.

MarcH 1974.

wR e.s. GOVERESENT PRinTING OFFICE; 1974 534043 19s