108 T.C. No.6

UNITED STATES TAX COURT

TRINOVA CORPORATION AND SUBSIDIARIES, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2931-94. Filed February 27, 1997.

P, a corporation, filed a consolidated tax return

with its affiliated companies. P operated a division

with assets that included certain section 38 assets

upon which investment tax credits (ITC) had been

claimed. P transferred the division assets to a wholly

owned subsidiary, G. P agreed to transfer its shares

in G to another shareholder, H, in return for H's

shares in P. The two transactions qualified for

nonrecognition status under secs. 351, 355, and

368(a)(1)(D), I.R.C. R determined a deficiency for P's

failure to include ITC recapture in income under sec.

47(a), I.R.C., on its 1986 consolidated tax return,

relying on Rev. Rul. 82-20, 1982-1 C.B. 6. Sec.

1.1502-3(f)(2) and (3), Income Tax Regs., particularly

Example (5) thereof, provides for no recapture. Held: 

Rev. Rul. 82-20, 1982-1 C.B. 6, is an unwarranted

attempt to limit the scope of the regulations; no ITC

recapture is includable in P's income.
- 2 -

1 Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the taxable years in issue,

and all Rule references are to the Tax Court Rules of Practice

and Procedure.

2 An additional issue, relating to the allocation of deductions

(continued...)

Frederick E. Henry, Jeffrey M. O'Donnell, and Julie C. H.

Walsh, for petitioners.

Nancy B. Herbert and Reid M. Huey, for respondent. 

OPINION

TANNENWALD, Judge: Respondent determined the following

deficiencies in petitioner's Federal income taxes and additions

to tax:

Addition to Tax

Year Deficiency Sec. 6661(a) 

1985 $ 117,988 --

1986 11,630,928 $1,429,687

1987 4,924,255 --

1988 834,875 --

After concessions, the issue for decision is whether petitioner

is liable for recapture in 1986 of investment tax credits (ITC)

claimed on certain section 381 assets that were transferred to a

wholly owned subsidiary, the stock of which was then transferred

out of the consolidated group in a tax-free transaction. If this

issue is resolved in favor of respondent, then the issue of the

 addition to tax under section 6661(a), which relates only

to the recapture issue, will have to be decided.2
- 3 -

2(...continued)

between subpart F income and non-subpart F income, will be

decided later by a separate opinion.

Background

This case was submitted fully stipulated under Rule 122. 

The stipulation of facts and the accompanying exhibits are

incorporated herein by this reference and found accordingly.

Petitioner, an accrual basis taxpayer, had its principal

offices in Maumee, Ohio, at the time it filed its petition

herein. Petitioner changed its name to Trinova from the LibbeyOwens-Ford Company (LOF) on July 31, 1986. Petitioner timely

filed a consolidated Federal income tax return with certain of

its subsidiaries for the years at issue with the Internal Revenue

Service Center, Cincinnati, Ohio, or the Internal Revenue Service

office in Toledo, Ohio. Petitioner was engaged in the fluid

power and plastics businesses, and in the manufacture of glass. 

The glass business was referred to as the "LOF Glass Division".

One of LOF's largest shareholders was Pilkington Brothers

(Pilkington), an English company, which owned 29 percent of

petitioner's common stock through its wholly owned U.S.

subsidiary, Pilkington Holdings, Inc. (Pilkington Holdings). Two

of petitioner's fourteen directors were associated with

Pilkington. In late 1985, Pilkington approached LOF and began

negotiations concerning the possibility of acquiring the glass

business. 
- 4 -

Earlier that year, on July 25, 1985, the board of directors

of LOF approved the transfer of the glass business to a wholly

owned subsidiary for valid business reasons. On February 19,

1986, LOF Glass, Inc. was incorporated as a wholly owned

subsidiary of LOF. On March 6, 1986, a "Transfer and Assumption

Agreement", amended on April 25, 1986, transferred to LOF Glass,

Inc., all assets associated with the LOF Glass Division,

including inventories and receivables, effective retroactively to

February 19, 1986. These assets also included section 38 assets

upon which LOF had previously claimed ITCs. Petitioner took no

formal action contemplating the liquidation of LOF Glass, Inc.,

in the event that the acquisition by Pilkington did not take

place. 

On March 7, 1986, LOF, Pilkington, and Pilkington Holdings

entered into an agreement, amended on April 28, 1986, whereby LOF

would transfer all of its shares of LOF Glass, Inc., to

Pilkington Holdings in exchange for all of the shares of

petitioner held by Pilkington Holdings. On April 28, 1986,

Pilkington Holdings exchanged 4,064,550 shares of LOF for the

shares of LOF Glass, Inc. LOF Glass, Inc., continued to operate

the glass business as a subsidiary of Pilkington Holdings and

used the section 38 assets in its trade or business. 

The parties have stipulated that petitioner recognized no

gain or loss upon the transaction whereby its glass business was

transferred to LOF Glass, Inc., pursuant to the provisions of
- 5 -

section 351 or sections 354, 355, and 368(a)(1)(D) (except as

required by such sections or section 357(c)), and that pursuant

to section 355 neither petitioner nor Pilkington Holdings

recognized any gain or loss upon the exchange of LOF Glass, Inc.,

shares for the LOF shares. 

Before February 19, 1986, income, deductions, and credits

with respect to the LOF Glass Division were included in

petitioner's return. From February 19, 1986, through April 28,

1986, deductions and credits with respect to LOF Glass, Inc. (the

subsidiary), were included as part of petitioner's consolidated

return. After April 28, 1986, LOF Glass, Inc., was no longer

part of petitioner, petitioner's affiliated group, or

petitioner's consolidated Federal income tax return. 

On its 1986 consolidated return, petitioner did not include

any amount of ITC recapture with respect to the LOF Glass, Inc.,

section 38 assets. Respondent determined that a $5,718,749 ITC

recapture arose from the April 1986 transaction. Petitioner does

not dispute the amount of the ITC recapture, should the Court

hold petitioner liable for it. 

Discussion

The investment tax credit provisions, now repealed but in

effect in respect of the taxable year 1986, provided for a tax

credit to taxpayers purchasing certain types of property for use

in their businesses. Whether petitioner is required to recapture

its investment tax credit turns upon the impact of a revenue
- 6 -

3 Sec. 47(b)(2) provided an exception for certain types of

reorganizations which is not applicable herein (and the parties

do not argue otherwise) because the assets transferred to LOF

Glass, Inc., did not constitute substantially all of the assets

of petitioner. See Baicker v. Commissioner, 93 T.C. 316, 326

(1989).

ruling on what other otherwise appears to be unqualified language

of a consolidated return regulation. The issue is not new to

this Court whose position has been rejected by two Courts of

Appeals. By way of background to our resolution of this judicial

conflict, we first turn to a description of the provisions in

respect of the investment tax credit pertinent to our analysis.

Section 47(a)(1) provided for recapture of the investment

tax credit: 

If during any taxable year any property is disposed of,

or otherwise ceases to be section 38 property with

respect to the taxpayer, before the close of the useful

life which was taken into account in computing the

credit under section 38 * * * [3]

Section 47(b) further provided:

For purposes of subsection (a), property shall not be

treated as ceasing to be section 38 property with

respect to the taxpayer by reason of a mere change in

the form of conducting the trade or business so long as

the property is retained in such trade or business as

section 38 property and the taxpayer retains a

substantial interest in such trade or business.

Section 47 sets out two prongs for the "mere change in the

form" test--first, a continuing trade or business, and second, a

retained substantial interest. The transactions herein clearly

satisfy the continuing trade or business requirement. However,
- 7 -

after the transaction in question, petitioner no longer had any

interest in its former glass business; LOF Glass operated as a

subsidiary of Pilkington Holdings. Thus, if section 47 were the

only provision involved in this case, this lack of retained

interest would be fatal to petitioner's position herein. Blevins

v. Commissioner, 61 T.C. 547 (1974); Aboussie v. Commissioner, 60

T.C. 549 (1973), affd. without published opinion 504 F.2d 758

(5th Cir. 1974); Soares v. Commissioner, 50 T.C. 909 (1968);

Purvis v. United States, 73-1 USTC par. 9157 (N.D. Ga. 1972).

However, the transactions herein took place in the

consolidated return context, which provides a different frame of

reference. Paragraph (f) of section 1.1502-3, Income Tax Regs.,

deals with early dispositions of section 38 assets of a member of

a consolidated group; subparagraph (2) of paragraph (f) provides:

(2) * * * a transfer of section 38 property from

one member of the group to another member of such group

during a consolidated return year shall not be treated

as a disposition or cessation within the meaning of

section 47(a)(1). If such section 38 property is

disposed of, or otherwise ceases to be section 38

property * * * before the close of the estimated useful

life * * *, then section 47(a)(1) or (2) shall apply 

* * * 

Subparagraph (3) of paragraph (f) provides:

(3) Examples. The provisions of this paragraph

may be illustrated by the following examples:

Example (1). P, S, and T file a consolidated

return for calendar year 1967. In such year S places

in service section 38 property having an estimated

useful life of more than 8 years. In 1968, P, S, and T

file a consolidated return, and in such year S sells
- 8 -

such property to T. Such sale will not cause section

47(a)(1) to apply.

* * * * * * *

Example (3). Assume the same facts as in example

(1), except that P, S, and T continue to file

consolidated returns through 1971 and in such year T

disposes of the property to individual A. Section

47(a)(1) will apply to the group * * *

* * * * * * *

Example (5). Assume the same facts as in example

(1), except that in 1969, P sells all the stock of T to

a third party. Such sale will not cause section

47(a)(1) to apply.

It is clear that the mere transfer of section 38 assets

within a consolidated group does not trigger recapture. Sec.

1.1502-3(f)(2), Income Tax Regs.; see also sec. 47(b); Tandy

Corp. v. Commissioner, 92 T.C. 1165 (1989); sec. 1.47-3(a),

Income Tax Regs. 

It is equally clear from Example (3) of the regulations that

a transfer of the section 38 assets by LOF Glass, Inc., to

Pilkington Holdings would have triggered the recapture of the

investment tax credit. In the same vein, the language of Example

(5) without more would dictate that the transfer of the stock of

LOF Glass, Inc., to Pilkington Holdings would not trigger the

recapture of such credit. In point of fact, the application of

Example (5) to the instant case is affected by a revenue ruling

and the opinions of two Courts of Appeals approving that ruling. 

In order to facilitate an understanding of the positions of the
- 9 -

parties and our views in respect thereto, we shall first discuss

the ruling and the two Courts of Appeals opinions.

In Rev. Rul. 82-20, 1982-1 C.B. 6, section 38 assets were,

pursuant to a prearranged plan, transferred by the parent

corporation to a subsidiary within a consolidated group in

exchange for stock of the subsidiary. Immediately thereafter,

the stock of the subsidiary was distributed to one of the two

shareholders in exchange for his stock in the parent. It was

assumed that the subsidiary would continue to use the section 38

assets in the same trade or business. Although the ruling

recognized that the transactions qualified under sections

355(c)(1) and 368(a)(1)(D), it held that the ITC recapture

provision of section 47(a)(1) applied on the ground that there

was a planned transfer of the property outside the group. 

Without making any reference to Example (5), the ruling reasons:

Although section 1.1502-3(f)(2)(i) of the regulations

creates an exception for transfers of section 38

property between members of a consolidated group that

would otherwise be dispositions under section 47(a)(1),

the exception is premised on the assumption that the

property is remaining within the consolidated group. 

When there is no intention at the time of transfer to

keep the property within the consolidated group, the

transaction should be viewed as a whole and not as

separate individual transactions. * * * [Rev. Rul.

82-20, 1982-1 C.B. 7.]

A factual situation similar to that involved herein was

subjected to scrutiny by this Court in Walt Disney Inc. v.

Commissioner, 97 T.C. 221 (1991), revd. 4 F.3d 735 (9th Cir.

1993). In holding that there was no ITC recapture upon the
- 10 -

transfer of the shares of a subsidiary out of the consolidated

group, we rejected respondent's argument that Example (5) was

premised on the section 38 assets' remaining in the consolidated

group and that there was no intention to observe this condition

at the time the plans resulting in the transfer of the section 38

assets outside the consolidated group in Walt Disney Inc. were

formulated. In so doing, we stated:

Although the example (5) stock sale occurs in the

year following the sale of the property within the

affiliated group, there is nothing in section 1.1502-

3(f)(2)(i) and (3), Income Tax Regs., requiring a

minimum waiting period. Indeed, as little as a 1-day

wait would be literally consistent with the examples in

the regulation: the sale from S to T in example (1)

could occur on December 31, 1968, and the sale of the

S[T] stock out of the affiliated group in example (5)

could occur on January 1, 1969. Nor is there any

express requirement that the idea for the stock

transfer arise after the sale of the property within

the affiliated group. Thus, respondent's contention

that the regulation is premised on the property

remaining in the affiliated group is not apparent from

the regulation itself. [Walt Disney Inc. v.

Commissioner, 97 T.C. at 228.]

Based upon this analysis, we held that the regulation

controlled, stating "When the authority to prescribe legislative

regulations exists, this Court is not inclined to interfere if

the regulations as written support the taxpayer's position." Id.

We adopted this view even though an "unwarranted benefit to the

taxpayer" might exist (id. at 229) and restated the position we

had taken in Woods Investment Co. v. Commissioner, 85 T.C. 274,

281-282 (1985), that if respondent were dissatisfied with the

import of a regulation, she should use her broad powers to amend
- 11 -

the regulation and not look to the courts to do it for her. 

Although we made no specific reference to Rev. Rul. 82-20, supra,

it is clear that we rejected its reasoning by adhering to Example

(5). Indeed, we reinforced such rejection by a lengthy

discussion and rejection of the role of the so-called step

transaction doctrine upon which Rev. Rul. 82-20 rested. See Walt

Disney Inc. v. Commissioner, 97 T.C. at 231-236; see also Tandy

Corp. v. Commissioner, supra, wherein we rejected the application

of the step transaction doctrine to the issue of an ITC recapture

in a nonconsolidated return situation. 

The next development in the scenario involved herein is the

decision of the Court of Appeals for the Second Circuit in

Salomon, Inc. v. United States, 976 F.2d 837 (2d Cir. 1992). A

factual situation substantially similar to that involved herein

and in Walt Disney Inc. v. Commissioner, supra, confronted the

Court of Appeals in Salomon. In deciding the case in favor of

the Government, the Court of Appeals for the Second Circuit

declared that the fact that, in Example (5), "the asset transfer

occurs in one year (1968) and the spinoff in the next year

(1969)", Salomon, Inc. v. United States, supra at 842,

constituted a significant difference from the situation dealt

with in Rev. Rul. 82-20, supra, and the Court of Appeals

concluded:

The Revenue Ruling thus complements CRR Example 5 by

dealing with transactions that occur rapidly and are

intended at their onset to transfer section 38 property
- 12 -

outside the consolidated group. The consolidated

return regulations state that "[t]he Internal Revenue

Code, or other law, shall be applicable to the group to

the extent the regulations do not exclude its

application." Treas. Reg. § 1.1502-80 (emphasis

added). Revenue Ruling 82-20 is within the ambit of

such "other law." We accordingly believe that the two

rulings are not in conflict, and may consistently be

read together. Judge Freeh did not err when he viewed

the two rulings as alternatives and then chose Revenue

Ruling 82-20 based on EMC's intention "immediately" to

spin-off EC following the asset transfer. [Salomon,

Inc. v. United States, 976 F.2d at 842-843.]

Having thus adopted the Government's position based upon its

conclusion that Rev. Rul. 82-20, supra, was reasonable and

consistent with prevailing law, the Court of Appeals for the

Second Circuit declined to discuss whether the step transaction

doctrine as such would, in any event, apply. Salomon, Inc. v.

United States, supra at 843-844.

The final development in the scenario is the reversal of our

decision in Walt Disney Inc. v. Commissioner, supra, by the Court

of Appeals for the Ninth Circuit. Relying heavily upon Salomon,

Inc. v. United States, supra, the Court of Appeals for the Ninth

Circuit also concluded that Rev. Rul. 82-20, supra, and Example

(5) were consistent and agreed with the Court of Appeals for the

Second Circuit, with the further comment that Rev. Rul. 82-20

qualified as "other law" under section 1.1502-80, Income Tax

Regs. Walt Disney Inc. v. Commissioner, 4 F.3d at 741 n.10. The

Court of Appeals for the Ninth Circuit made no reference to the

step transaction doctrine.
- 13 -

Against the foregoing background, we proceed to consider the

positions of the parties. Relying on the position we took in

Walt Disney Inc. v. Commissioner, supra, petitioner contends that

the regulations, section 1.1502-3(f)(2) and (3), and Example (5)

in particular, Income Tax Regs., are dispositive and that the

step transaction doctrine has no application herein. Respondent,

relying on Rev. Rul. 82-20, supra, and the status accorded it by

the Courts of Appeals for the Second and Ninth Circuits in

Salomon, Inc. v. United States, supra, and Walt Disney Inc. v.

Commissioner, supra, argues in effect that Rev. Rul. 82-20,

supra, operates independently of Example (5) and should control

and that, in any event, the application of the step transaction

doctrine should result in the recapture by petitioner of the

investment tax credit. We agree with petitioner.

With all due respect, we disagree with both the result and

the reasoning of the Courts of Appeals and adhere to the position

we took in Walt Disney Inc. v. Commissioner, 97 T.C. 221 (1991).

We think that the fact that the transfer of the assets and the

transfer of the stock occurred in the same, rather than

different, taxable years does not provide a meaningful basis for

distinguishing Rev. Rul. 82-20, supra, from Example (5) of the

regulations. Indeed, as we have already pointed out, see supra

pp. 9-10, we specifically refused to give weight to this element

in Walt Disney Inc. v. Commissioner, supra. Our continued

adherence to this point of view is reinforced by the fact that
- 14 -

the time span element is also present in Example (3) where the

section 38 assets are transferred in a different taxable year and

the recapture of the investment tax credit is mandated. The

contrast between these two examples highlights the fact that it

is what is transferred and not when the transfer occurs that is

significant. Indeed, if timing was a significant element in

Example (5), one would think that respondent would have referred

to Example (5) and this element in Rev. Rul. 82-20, supra, and

thus provided the tax-paying public with notice of respondent's

restrictive interpretation of Example (5) rather than leaving

such interpretation to unarticulated alleged inference. We do

not think the "assumption" referred to in the ruling, see supra

p. 9, constitutes a meaningful signal to this effect.

In the foregoing context, the conflict between Rev. Rul. 82-

20, supra, and Example (5) becomes apparent. The question then

becomes what, if any, weight we should give to Rev. Rul. 82-20,

supra. We think the Courts of Appeals for the Second and Ninth

Circuits accorded the ruling undue weight and that revenue

rulings play a lesser role than the language of the opinions of

those Courts of Appeals seems to indicate. We see no purpose to

be served in engaging in a detailed discussion of the differences

in judicial articulation which can be found in this arena. We

note, however, that the Court of Appeals for the Sixth Circuit,

to which an appeal herein will lie, has stated: 
- 15 -

A Revenue Ruling, however, is not entitled to the

deference accorded a statute or a Treasury Regulation. 

* * * [Threlkeld v. Commissioner, 848 F.2d 81, 84 (6th

Cir. 1988), affg. 87 T.C. 1294 (1987).]

As we see it, Example (5) and not Rev. Rul. 82-20, supra,

provides the key to decision herein. It may well be that Example

(5) provides an unwarranted benefit to the taxpayer, but such a

consideration was not sufficient to tip the scales in Woods

Investment Co. v. Commissioner, 55 T.C. 274 (1985). See supra p.

10. We think as we did in Walt Disney Inc. v. Commissioner,

supra, that the same approach applies herein. Respondent's

remedy is not to seek to modify the regulation by judicial action

or administrative ruling, but to change the regulation itself. 

See Walt Disney Inc. v. Commissioner, 97 T.C. at 229 (quoting at

length from Woods Investment Co. v. Commissioner, 85 T.C. at 281-

282)); see also Honeywell Inc. v. Commissioner, 87 T.C. 624, 635

(1986) (respondent had the right to amend the regulations but

could not do so "by a revenue ruling or by judicial

intervention"); Peninsula Steel Products & Equip. Co. v.

Commissioner, 78 T.C. 1029, 1052 (1982) (ruling disapproved in

light of regulation); Sims v. Commissioner, 72 T.C. 996, 1006

(1979) (rulings do not have the force of regulations).

Our approach herein obviously also reflects our disagreement

with that of the Courts of Appeals for the Second and Ninth

Circuits in according Rev. Rul. 82-20, supra, the status of

"other law" in order to apply section 1.1502-80, Income Tax Regs.
- 16 -

See supra p. 11. See Norfolk S. Corp. v. Commissioner, 104 T.C.

13, 45-46 (1995) (revenue rulings "do not have the force of

law"), supplemented by 104 T.C. 417 (1995). 

Finally, we turn to respondent's attempt to salvage her

position by arguing that the step transaction doctrine

constitutes "other law" within the meaning of section 1.1502-

80(a), Income Tax Regs., which provides:

The Internal Revenue Code, or other law, shall be

applicable to the group to the extent the regulations

do not exclude its application. * * *

We rejected respondent's attempt to invoke this provision in Walt

Disney Inc. v. Commissioner, 97 T.C. at 231-236. In our opinion

in that case, we set forth a detailed analysis of a factual

situation substantially similar to that involved herein and

concluded that there were no "meaningless or unnecessary steps"

that should be ignored as required by the step transaction

doctrine. We emphasized that respondent had blessed a

reorganization plan. See id. at 225. We see no need to repeat

that analysis herein where the facts are at least as strong as

those which were involved in Walt Disney. In this connection, it

is significant that in this case respondent has stipulated that

the requirements of section 355 were met. By so doing,

respondent has stipulated that there was a business purpose,

i.e., substance, to the transfer by petitioner to LOF Glass,

Inc., a position which is inconsistent with her position herein

that petitioner disposed of the assets by in effect transferring
- 17 -

them to Pilkington Holdings. Under these circumstances, we think

that the analysis of the Courts of Appeals for the Second Circuit

in Salomon, Inc. v. United States, 976 F.2d 837 (1992), and the

Ninth Circuit in Walt Disney Inc. v. Commissioner, supra, based

on "economic reality" and "substance", which are key elements of

the step transaction doctrine, misses the mark in terms of the

proper disposition of this case. See Ginsburg & Levin, Mergers,

Acquisitions and Buyouts, sec. 1002.1.1.4 (July 1996).

In sum, we hold for petitioner on the issue of the recapture

of the investment tax credit. Such being the case, there is no

addition to tax under section 6661. We again point out that this

opinion resolves only the investment tax credit recapture issue

and that an additional issue relating to the allocation of

deductions is still before the Court. See supra note 2.

Reviewed by the Court.

COHEN, CHABOT, GERBER, PARR, WHALEN, COLVIN, CHIECHI, LARO,

FOLEY, and GALE, JJ., agree with this majority opinion.

HALPERN, J., did not participate in the consideration of

this opinion.
- 18 -

 SWIFT, J., respectfully dissenting: With the benefit of the

analyses provided in the opinions of the Second and Ninth Circuit

Courts of Appeals in Salomon, Inc. v. United States, 976 F.2d 837

(2d Cir. 1992), and Walt Disney, Inc. v. Commissioner, 4 F.3d 735

(9th Cir. 1993), we should recognize the error made in our

opinion in Walt Disney, Inc. v. Commissioner, 97 T.C. 221 (1991),

and sustain respondent's position in this case.

The majority suggests that the issue herein turns primarily

on whether a particular provision of the consolidated return

regulations (namely, sec. 1.1502-3(f)(3), Example (5), Income Tax

Regs.) controls over a revenue ruling (namely, Rev. Rul. 82-20,

1982-1 C.B. 6). The majority argues that the above Courts of

Appeals, in the cited opinions, give undue weight to the revenue

ruling and ignore what the majority regards as the clear mandate

of the regulation under section 1502. 

The majority is correct in stating that revenue rulings do

not generally constitute legal precedent or "other law". As the

language quoted below, however, from each of the cited opinions

indicates, neither the U.S. Courts of Appeals for the Second nor

the Ninth Circuit rely exclusively on the conclusive effect of

the revenue ruling. Rather, both rely heavily on "economic

reality" and the "substance-over-form" doctrines, which are

simply broader labels for, and which encompass, the step

transaction doctrine. 
- 19 -

The Court of Appeals for the Second Circuit in Salomon, Inc.

v. United States, supra at 842-843, explained as follows:

In substance, if not in form, the direct and the circuitous

transaction are the same. See Commissioner v. Court Holding

Co., 324 U.S. 331, 334, 65 S.Ct. 707, 708, 89 L.Ed. 981

(1945). Each achieves a rapid transfer of section 38

property outside the group. To distinguish between them

would deny economic reality. See Gregory v. Helvering, 293

U.S. 465, 470, 55 S.Ct. 266, 268, 79 L.Ed. 596 (1935)

(refusing to "exalt artifice above reality" in determining

tax liability). Moreover, such a holding would allow the

common parent of a consolidated group, such as * * * [the

parent], to move section 38 property outside the group

without paying recapture taxes simply by first transferring

the property to a member subsidiary and then distributing

the subsidiary's stock to the third-party. * * *

* * * * * * *

The rapidity with which these components follow one another

suggest that they are, in substance, parts of one overall

transaction intended to dispose of the section 38 assets

outside of the consolidated group. * * * These factual

circumstances, timing and intent * * *. * * * lead to the

conclusion that the two components are steps in a larger

transaction which, when viewed as a whole, constitutes a

section 47(a)(1) "disposition." * * *

* * * * * * *

Under these circumstances, the transaction is, in substance,

a means of moving the assets outside the group. * * * 

The Court of Appeals for the Ninth Circuit in Walt Disney,

Inc. v. Commissioner, supra at 741, relied heavily upon the

analysis of the Court of Appeals for the Second Circuit, quoted

from the above language, and stated the following -- 

"in substance, if not in form, the direct and the

circuitous transaction are the same" and "to
- 20 -

distinguish between them would deny economic reality"

and would allow the common parent of a consolidated

group to circumvent easily the recapture requirement.

* * *

The position we adopted in our opinion in Walt Disney, Inc.

v. Commissioner, 97 T.C. at 221, failed to apply properly the

substance-over-form doctrine and failed to give proper weight to

section 1.47-3(f)(1), Income Tax Regs., which provides clearly

that to the extent ownership of an affiliated transferee

corporation changes hands as part of the transfer of property to

the transferee corporation, a taxable disposition has occurred

under section 47. See sec. 1.47-3(f)(1), (2), (6) Examples (2),

(3), and (4), Income Tax Regs.

The above regulations under section 1.47-3(f)(1), (2) (6),

should be read together with section 1.1502-3(f)(3), Income Tax

Regs. Where a change in ownership of an affiliated transferee

company is contemplated at the time of a transfer of section 38

property and where the change in ownership that occurs is, in

substance, in economic reality, and/or under the step transaction

doctrine, integral to the transfer of the property outside the

affiliated group, the transfer should be treated, to the extent

of the change in ownership of the transferee corporation, as a

taxable disposition under section 47.

The weight to be given a revenue ruling is not the issue in

this case. Rather, the issue is the validity of the underlying

rationale of Rev. Rul. 82-20, 1982-1 C.B. 6, -- namely, whether
- 21 -

the transaction before us and its taxability under section 47 is

controlled by the substance thereof. As is explained in the

cited ruling:

When there is no intention at the time of transfer to keep

the property within the consolidated group, the transaction

should be viewed as a whole and not as separate individual

transactions. * * *

Because the transfer * * * is a step in the planned transfer

of the property outside the group, section 1.1502-3(f)(2)(i)

of the regulations does not apply. [Rev. Rul. 82-20, 1982-1

C.B. 6; citations omitted.]

In Tandy Corp. v. Commissioner, 92 T.C. 1165 (1989), we held

that, on the particular facts of that case, recapture under

section 47 was not appropriate where a change in ownership of a

transferee corporation occurred in a year after a transfer of

property to the transferee corporation. With respect, however,

to a fact situation similar to the instant case (where a transfer

of property and an ownership change in the transferee corporation

effectively occur during the same taxable year and as part of the

same integral transaction), we explained in Tandy Corp. v.

Commissioner, supra, that section 47 recapture would be

triggered, as follows:

To treat * * * [the taxpayer] as having relinquished during

the year before the Court a "substantial interest" as

contemplated by section 1.47-3(f)(1)(ii)(b), Income Tax

Regs., would require a concomitant finding that such an

interest passed to * * * [the taxpayer's] shareholders at

the same time. * * * [Id. at 1171.]
- 22 -

The majority op. pp. 16-17 implicitly acknowledges that the

substance-over-form and step transaction doctrines have

application as “other law” in the consolidated return context

under section 1.1502-80, Income Tax Regs. The majority, however,

summarily dismisses the application of such doctrines to the

specific facts of this case because each step of the

reorganization plan adopted by petitioner had a business purpose. 

Both the Second and the Ninth Circuit Courts of Appeals in

the above-cited opinions applied the substance-over-form doctrine

in spite of the presence of a business purpose for each step of

the reorganizations involved in those cases and, as stated above,

concluded that the substance thereof, for purposes of section 47,

constituted dispositions of property outside the consolidated

group, thus triggering recapture under section 47. See also the

District Court’s opinion in Salomon v. United States, 92-1 USTC

par. 50,155, 70 AFTR 2d par. 92-5872 (S.D.N.Y. 1992).

 In King Enters., Inc. v. United States, 189 Ct. Cl. 466,

418 F.2d 511, 516 n.6 (1969), the Court of Claims explained that

various courts have --

enunciated a variety of doctrines, such as step

transaction, business purpose, and substance over form. 

Although the various doctrines overlap and it is not

always clear in a particular case which one is most

appropriate, their common premise is that the

substantive realities of a transaction determine its

tax consequences.
- 23 -

With regard more specifically to the question of the

relationship between the step transaction doctrine and the

business purpose aspect of a transaction and in the context of

analyzing a section 332 liquidation, the Court of Appeals for the

Tenth Circuit in Associated Wholesale Grocers, Inc. v. United

States, 927 F.2d 1517 (10th Cir. 1991), rejected the contention

that a valid business purpose precludes application of the step

transaction doctrine. The Court of Appeals explained as follows:

Most cases applying the step transaction doctrine, far

from identifying business purpose as an element whose

absence is prerequisite to that application, do not

even include discussion of business purpose as a

related issue. In some cases, the existence of a

business purpose is considered one factor in

determining whether form and substance coincide. In

others, the lack of business purpose is accepted as

reason to apply the step transaction doctrine. We have

found no case holding that the existence of a business

purpose precludes the application of the step

transaction doctrine. [Associated Wholesale Grocers,

Inc. v. United States, 927 F.2d at 1526-1527; fn. refs.

omitted.]

The Court of Appeals for the Tenth Circuit in Associated

Wholesale Grocers., Inc. v. United States, supra at 1527 n.15,

also cited our opinion in Vest v. Commissioner, 57 T.C. 128

(1971), revd. in part and affd. in part on other grounds 481 F.2d

238 (5th Cir. 1973), and commented thereon as follows: 

After identifying a business purpose, the * * * [Tax

Court in Vest v. Commissioner] undertakes a thorough

discussion of whether to treat a stock exchange as a

step transaction. 57 T.C. at 145. The * * * [Tax

Court] remarked “[t]he fact that there were business
- 24 -

purposes for the incorporation of V Bar is an

indication that its formation was not a step mutually

interdependent with the subsequent stock exchange” and

continued to consider other factors, including the

existence of a binding commitment, the timing of the

steps, and the actual intent of parties. Id. at 145-

46. (Emphasis added [by Tenth Circuit]). Far from

precluding step transaction analysis, the business

purpose was not even considered the most significant

factor in Vest. * * *

In Yoc Heating Corp. v. Commissioner, 61 T.C. 168, 177

(1973) (Court reviewed), we expressly commented on the

relationship between the step transaction doctrine and the

business purpose aspect of a transaction, and we did so in the

particular context of the reorganization provisions of the Code,

which were also involved in that case, as follows:

Our path to decision is framed within two cardinal

principles, which apply in the reorganization area and

which are so well established as not to require

supporting citations. First, the fact that the form of

the transaction conforms to the literal wording of the

definition of a reorganization is not controlling. 

Second, when a transaction is composed of a series of

interdependent steps, each undertaken to achieve an

overall objective, the various steps should be viewed

in their entirety for the purpose of determining its

tax consequences--the so-called “integrated

transaction” doctrine. * * * The fact that for valid

business reasons there was a delay of several months

before * * * [the new entity] came into existence and

completed the acquisition does not militate against

* * * [application of the step transaction doctrine]. 

[Citations omitted.] 

It is acknowledged that the Commissioner in Rev. Rul. 79-

250, 1979-C.B. 156, suggested that, in the context of certain

reorganization transactions, preliminary and related transactions
- 25 -

or steps will not necessarily be stepped together and ignored

where each such preliminary step constitutes a permanent

alteration of a previous bona fide business relationship. That

general statement in Rev. Rul. 79-250, however, does not preclude

application of the step transaction doctrine, the substance over

form doctrine, or the integrated transaction doctrine to the

facts of this case involving recapture of investment tax credit

under section 47. See also Associated Wholesale Grocers., Inc.

v. United States, supra at 1526-1527; Rev. Rul. 96-29, 1996-24

I.R.B. 5.

Based on the above authority, I believe that the majority

herein errs in suggesting, majority op. pp. 16-17, that the

business purpose associated with the transfer of petitioner’s

glass division to a subsidiary and with the change in ownership

of the subsidiary provides, for purposes of section 47 recapture,

the sum and substance of the transaction before us and

effectively precludes any meaningful analysis under the

substance-over-form, the step transaction, or the integrated

transaction doctrines.

A brief analysis of the substance and steps of the

transactions before us is appropriate. 

The Court of Appeals for the Sixth Circuit, to which an

appeal in this case would lie, has adopted the end result

approach of the step transaction doctrine. In Brown v. United
- 26 -

States, 868 F.2d 859, 862-863 (6th Cir. 1989), the Court of

Appeals for the Sixth Circuit stated as follows -- 

the essence of the step transaction doctrine is that an

“integrated transaction must not be broken into

independent steps or, conversely, that the separate

steps must be taken together in attaching tax

consequences”. * * *

* * * * * * *

Under the end result test of the step transaction

doctrine, “purportedly separate transactions will be

amalgamated into a single transaction when it appears

that they were really component parts of a single

transaction intended from the outset to be taken for

the purpose of reaching the ultimate result.” King

Enters., Inc. v. United States, 418 F.2d at 516. * * * 

Here the parties have stipulated the following facts with

regard to the transfer of LOF’s glass division and the change in

ownership of LOF Glass. 

Late in 1985, representatives of Pilkington approached LOF

concerning acquisition of LOF’s glass division. During November

of 1985 through early March of 1986, negotiations regarding the

possible acquisition took place. 

On March 6, 1986, LOF transferred the glass division to LOF

Glass, the new subsidiary that had been formed for that purpose. 

One day later, on March 7, 1986, LOF entered into a 45-page 

agreement to transfer to Pilkington Holdings all of its stock

interest in LOF Glass in exchange for Pilkington Holdings’ stock

interest in LOF. 
- 27 -

The March 7, 1986, agreement to exchange stock expressly

refers to the March 6, 1986, transfer of the glass division to

LOF Glass and establishes the integrated nature of these

transactions.

 Seven weeks later, on April 28, 1986, the exchange of stock

that had been agreed to on March 7, 1986, was consummated. 

After April 28, 1986, LOF Glass was no longer part of LOF’s

affiliated group and no longer was included in LOF’s consolidated

Federal income tax return.

 It is apparent that the transfer of the glass division to

LOF Glass and the agreement one day later to transfer the stock

of LOF Glass outside the LOF affiliated group constituted an

integrated transaction intended to move the glass division (and

the related section 38 property) outside of LOF’s affiliated

group. 

Based on this stipulated factual record and on this issue on

which petitioner has the burden of proof (see Rule 142(a)), only

one conclusion can be reasonably reached -- namely, that in spite

of the qualification of the transaction as a reorganization under

section 368(a)(1)(D)(allowing LOF to avoid recognizing taxable

gain or loss on the transfer of the glass business and allowing

LOF and Pilkington Holdings to avoid recognizing taxable gain or

loss on their exchange of stock), the substance of the integrated

transaction by which LOF’s glass division in 1986 was transferred

outside the LOF affiliated group constituted a disposition of
- 28 -

property under section 47 and triggered recapture of investment

tax credit on any section 38 property that was included with the

property transferred.

 Section 1.1502-3(f)(3), Example (5), Income Tax Regs.,

simply is not applicable. That example involved, in year 1, only

a transfer of property within the affiliated group. After the

transfer, the property stayed within the affiliated group and was

included in the consolidated return for the remainder of year 1. 

In year 2, no further transfer of property occurred. Rather, in

an apparently unrelated transaction, a third party purchased the

stock of the transferee, and the transferee, which had received

the property in year 1, left the affiliated group. For the first

time in year 2, the property will not be included in the

consolidated return of the affiliated group.

The transaction described in Example (5) of the above

regulation bears little resemblance to that involved in this case

(where a transfer of property and a change in ownership of the

transferee corporation occur effectively within the same taxable

year as part and parcel of a single plan and transaction under

which the transferee corporation promptly leaves the affiliated

group and is no longer part of the affiliated group for purposes

of inclusion in the transferor corporation’s consolidated tax 

return). Example (5) of the above regulation under the

consolidated return regulations should not be read to immunize
- 29 -

the integrated transaction before us from recapture under section

47.

It bears noting that the facts of the instant transaction

are distinguishable from the facts of Salomon v. Commissioner,

976 F.2d 837 (2d Cir. 1992), and Walt Disney, Inc. v.

Commissioner, 4 F.3d 735 (9th Cir. 1993). Although the spin-offs

in those cases resulted in a change in the identity of the

corporate holder of the section 38 property, that property

remained in the same economic family, with the same shareholders

holding the stock of the new corporate owner of the section 38

property. In the instant case, at the inception of the

transactions, Pilkington held only a 29-percent interest in the

stock of LOF. As a result of the completion of the split off,

Pilkington acquired a 100-percent interest in the stock of LOF

Glass, reflecting a 71-percent shift in the ownership of the

corporation owning the section 38 property after the split off.

For the reasons stated herein and in the above opinions of

the courts of appeals, I dissent.

JACOBS, WELLS, RUWE, BEGHE, and VASQUEZ, JJ., agree with

this dissent.
- 30 -

4 Expiration of all Hart-Scott-Rodino waiting periods, receipt

of tax opinions that the split-off would be a tax-free exchange

under section 355, and satisfaction of all other stated

conditions, must have occurred or have been waived between March

6 and April 28, 1986.

BEGHE, J., dissenting: Having joined Judge Swift's dissent,

I add a few words in an effort to provide some further support

and explanation. The case at hand is an appropriate occasion to

apply the intent, end result, integrated transaction version of

the step-transaction doctrine to support a finding of early

disposition that results in ITC recapture.

 Petitioner's initial drop-down to LOF Glass of the glass

business and its section 38 assets, which occurred on March 6,

1986, was followed 1 day later by the single-spaced, 45-page,

March 7, 1986, agreement for the split-off exchange of shares of

petitioner for shares of LOF Glass by Pilkington Holdings. The

split-off occurred on April 28, 1986, pursuant to that agreement,

as amended in immaterial respects. Although the parties

stipulated that the drop-down occurred for valid business

reasons, reasons that were presumably independent of the

impending divestiture, there were no substantial conditions in

the March 7, 1986, agreement to consummation of the split-off.4

The majority, uncritically following our opinion in Walt

Disney, Inc. v. Commissioner, 97 T.C. 221 (1991), revd. 4 F.3d

735 (9th Cir. 1993), assumes an unwarranted equivalence between

the two events described in the section 1502 regulation examples
- 31 -

5 There are at least three significant differences between the

facts of the examples in the section 1502 regulation and the

facts of our case. In the examples, the sale of the section 38

assets and the sale of the purchaser's stock occur in different

tax years, whereas in our case they occur in the same year; the

first sale in the examples appears to be made to a preexisting

member of the group, whereas in our case the transfer is made to

a newly created subsidiary organized to do the deal, including

the second step; and the examples concern two unrelated sales,

whereas the first transaction in our case is a drop-down of

assets that is an integral and necessary step of the plan to

accomplish the agreed upon tax-free split-off exchange of shares

that is intended to follow.

6 Events should be deemed to have a connection for tax

purposes when dictated by the logic of events that has to do with

cause and effect relationships and necessary connections or

outcomes. Under that formulation, there is no connection between

the sales in the examples in the sec. 1502 regulation and there

is a connection between the drop-down and the split-off in the

case at hand.

and the LOF Glass divestiture transaction.5 Contrary to the

majority's assumption, the unadorned descriptions of the events

in the regulation's two examples indicate the lack of connection

between the intragroup sale of section 38 assets in year 1 and

the sale of the stock of the purchaser to a third party outside

the group in year 2. The majority goes on to disregard the

obvious connection--supplied by the intent, manifested

contemporaneously with the drop-down to LOF Glass, to accomplish

the end result of the split-off--that binds the steps in the case

at hand in an integrated transaction.6

The transactions in the case at hand are not just two

unconnected sales. They evidence a flow of events that comprise

a two-step divestiture, the second step of which is an exchange
- 32 -

7 Contrary to the views of those who would read the intent,

end result, integrated transaction version of the steptransaction doctrine out of the judicial arsenal, see, e.g.,

Ginsburg & Levin, Mergers, Acquisitions and Buyouts, secs.

208.4.5, 608.1, 608.3.1, 610.9, 1002.1.4 (July 1996); Bowen, The

End Result Test, 49 Taxes 722 (1994), there is an appropriate

role for this "weak" version of the step-transaction doctrine in

situations such as the case at hand.

of shares under section 368(a)(1)(D) that qualifies for

nonrecognition under section 355. The initial drop-down of

assets into a subsidiary in exchange for its shares is essential

to enable the intended divestiture to be accomplished by a share

for share exchange that entitles the second step to

nonrecognition of gain to both parties. The connection that

binds the two steps, as in J.E. Seagram Corp. v. Commissioner,

104 T.C. 75, 91-99 (1995), is manifested in the plan of

reorganization, which embodies the intent to achieve the end

result.7 Although the first step in the case at hand has an

independent business purpose in the sense that it would not have

been fruitless in all events to take that step--after all, a

corporation engaged in more than one business almost invariably

has a business purpose for dropping a business into a subsidiary,

if only to protect the assets of its other businesses from the

liabilities and risks that are encapsulated by the drop-down--the

independent business purpose of the first step in the case at

hand is trumped by the more important business purpose of

completing the divestiture by means of a tax-free exchange, which

relegates the first step to a subordinate implementing role.
- 33 -

8 The terms "weak" and "strong" are used here in the

mathematical sense of "subject to less/more exacting or numerous

conditions". See Oxford English Dictionary, Entries under

"weak", 19.f(b) and "strong", 19.c (2d ed. 1995). Analogous

usages occur in logic, physics, and cosmology. On "weakened" and

"strengthened" moods of the syllogism, see Cohen & Nagel, An

Introduction to Logic and Scientific Method 84, 86 (1934). On

the "strong" force in elementary particle physics, which holds

the nucleus together, and the "weak" force, which causes the

decay of many of the elementary particles, see, e.g., 28

Encyclopedia Britannica, Subatomic Particles 239-240 (15th ed.

1993). On the "weak" and "strong" anthropic principles regarding

the state of the universe, see Hawking, A Brief History of Time

124-126 (1988). See also Penrose, The Emperor's New Mind 17-23

(1989), on "strong" artificial intelligence.

9 As in West Coast Mktg. Corp. v. Commissioner, 46 T.C. 32

(1966).

The integrated transaction approach is a legitimate "weak"

version of the step-transaction doctrine, as contrasted with the

"strong" requirements8 that must be satisfied, under its binding

commitment and interdependence versions, in order to disregard

unnecessary intermediate steps.9 The creation of and drop-down

to LOF Glass were necessary to accomplish the divestiture

(separating LOF Glass, the new holder of the glass business and

its section 38 assets, from the affiliated group), which was the

intended end result that followed the initial step. The

intention to effect that end result suffices to justify

application of the integrated transaction approach to conclude

that the section 38 assets left the economic family of

petitioner's affiliated group in a way that requires ITC

recapture. 

JACOBS, J., agrees with this dissent.