Case Name: Trinova Corporation and Subsidiaries, Petitioner v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1997-02-27
Citations: 108 T.C. 68
Docket Number: Docket No. 2931-94
Parties: Trinova Corporation and Subsidiaries, Petitioner v. Commissioner of Internal Revenue, Respondent
Judges: Cohen, Chabot, Gerber, Parr, Whalen, Colvin, Chiechi, Laro, Foley, and Gale, JJ., agree with this majority opinion.
Reporter: Reports of the Tax Court of the United States
Volume: 108
Pages: 68–89

Head Matter:
Trinova Corporation and Subsidiaries, Petitioner v. Commissioner of Internal Revenue, Respondent
Docket No. 2931-94.
Filed February 27, 1997.
Frederick E. Henry, Jeffrey M. O’Donnell, and Julie C. H. Walsh, for petitioner.
Nancy B. Herbert and Reid M. Huey, for respondent.

Opinion:
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 38 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.
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 Libbey-Owens-Ford Co. (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 Bros. (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 14 directors were associated with Pilkington. In late 1985, Pilkington approached LOF and began negotiations concerning the possibility of acquiring the glass business.
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 ITC's. 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 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 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 ruling on what 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
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, 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 a 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 j of a consolidated group; subparagraph (2) of paragraph (fb provides: J
(2) a transfer of section 38 property from one member of the group a 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 such property to T. Such sale will not cause section 47(a)(1) to apply.
if: if: if; if: ífs :}:
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 j to the group '
if: if: if: ‡ if: fjt Hi
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 j 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 section 1.1502-3, Income Tax Regs., 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 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. Rui. 82-20, 1982-1 C.B. at 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 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 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, supra, 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 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.
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. Rui. 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 p. 74, 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 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. 73, 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:
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 (1986).]
As we see it, Example (5) and not Rev. Rul. 82-20, supra, provides the key to decision herein. It may well be that ¡jExample (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, 85 T.C. 274 (1985). See supra p. 74. 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, supra at 281-282)); see also Honeywell Inc. v. Commissioner, 87 T.C. 624, 635 (1986) (the Commissioner 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 41979) (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. See supra p. 75. See Norfolk S. Corp. v. Commis sioner, 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 Inc. 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 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, 4 F.3d 735 (9th Cir. 1993), 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.
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.
An additional issue, relating to the allocation of deductions between subpt. F income and nonsubpt. F income, will be decided later by a separate opinion.
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).