Earl Warren: Libson Shops (Inaudible) Officer Gustave F. Koehler et al., Mr. Lowenhaupt, and before you start with your argument, I want to announce that in the order list yesterday there was a -- a mistake. Application had -- petitioner had been made to file to two briefs, one in 216 and one in 64. And the order list shows that the request was granted in 216 but was denied in 64. That is a mistake. We -- we intended to grant permission also in 64 so that may be filed and counsel may respond if they desire to it. Now, you may proceed, Mr. --
Henry C. Lowenhaupt: May it please the Court. I'm glad to move now from a somewhat tempestuous area of, maybe, Karl -- Karl Marx to that which may be a little calmer, the sphere of Adam Smith. This case involves a question of the taxation of income that comes to this Court from the Court of Appeals for the Eighth Circuit. The precise question presented is whether or not the petitioner here, the surviving corporation in a merger, may carry over and deduct from its income the operating losses of three corporations which were a component corporations in that merger. The facts are stipulated, fully set out in the briefs, maybe summarized very briefly here. Prior to 1949, there were 17 corporations, each with the name Libson as part of its name. Some of them were Missouri corporations, some of them were Illinois corporations. They conducted retail business in 16 locations. The 17th corporation was a management company. The stock of all the corporations was owned by the same individuals in identical proportions with one nsignificant exception, that one of the corporations was the wholly-owned subsidiary of another corporation. That of course doesn't vary the substantial ownership of the corporations, all of which were owned in the same proportions, add identically. Three of these corporations sustained net operating losses. At the end of the fiscal year in 1949, all of the corporations were merged into one corporation under the statutory provisions of the Missouri and Illinois corporation loss of the states to their incorporation. Petitioner here is the sole surviving corporation in that merger. Of course, the fact that there were 17 corporations doesn't mean that there were 17 separate businesses. There were 17 accounting units conducting business at 16 locations under one common management. This appears to be but one business. Basically, the fact that it was one business is the reason for the merger. This petitioner deducted from its income consisting of the income of all the locations. For the year following the merger, the net operating loss suffered in three of those locations which appeared in the accounts of its component corporation, three of its component corporations. And the only question presented here is the propriety of that deduction.
Speaker: Mr. Lowenhaupt, were the 17 corporations -- they all brought into being the same as to all four of them for the initial enterprise?
Henry C. Lowenhaupt: No, as new locations were opened from time to time, new corporations were formed. Many of them were organized at once succeeding to a -- a business conducted as sole proprietorship.
Stanley Reed: Does that mean they were subsidiaries?
Henry C. Lowenhaupt: No.
Stanley Reed: You don't mean that, do you?
Henry C. Lowenhaupt: No, no. One corporation was the wholly-owned subsidiary of one other corporation. Other than that, there were 16 corporations (Voice Overlap) --
Stanley Reed: 16 of that. Now, each -- each of the 16, what about the stockholders?
Henry C. Lowenhaupt: Were the same individuals, individual shareholders.
Stanley Reed: It's the three -- three individuals --
Henry C. Lowenhaupt: Each --
Stanley Reed: -- owned all of the stock in the 17 different corporations?
Henry C. Lowenhaupt: That's right. All owning it in the same proportions.
Stanley Reed: The three of it in the same proportion.
Henry C. Lowenhaupt: Yes. As a matter of fact, there were now three but the precise number makes no difference.
Stanley Reed: (Voice Overlap) --
Felix Frankfurter: You said that as new units came into being, they were incorporated as it were, is that right?
Henry C. Lowenhaupt: As new retail locations were established.
Felix Frankfurter: A corporation for each new unit, is that right?
Henry C. Lowenhaupt: From time to time, yes.
Felix Frankfurter: From time to time.
Henry C. Lowenhaupt: However, on the original formation of the business, as I understand it, there were several incorporated, four locations previously conducted.
Felix Frankfurter: Was there any -- was there -- were there any considerations in the corporate law that prevented the existing -- the existing corporations from -- of having the new units come under the umbrella of the old corporations?
Henry C. Lowenhaupt: There was no reason in corporate law. The reason was based probably on business judgment, desirability of limiting liability in a new least similar considerations.
Felix Frankfurter: Well now, at least, these new corporations came into existence for business reasons.
Henry C. Lowenhaupt: Apparently, and the merger occurred probably for the reason that it was desired to have better credits than a single corporation could sustain.
William J. Brennan, Jr.: They all sell the same product?
Henry C. Lowenhaupt: They all sell the same product and operate under common management.
William J. Brennan, Jr.: Centralized buying?
Henry C. Lowenhaupt: Yes. The management corporation so called.
William J. Brennan, Jr.: Did the buying?
Henry C. Lowenhaupt: Did the buying and management.
William J. Brennan, Jr.: And none of the corporations was a manufacturer?
Henry C. Lowenhaupt: None was manufacturing. As to the motivations which led both to the separate incorporation and to the merger, those have never been an issue. Other sections of the statute are addressed to various kinds of transfer acquisitions, and the like, with particular motivations. The application of those sections has never been asserted, and therefore, the motivations have never become a direct issue in this case, specifically Section 129 applies with some -- when certain motivations are present. That section hasn't been alleged, hasn't been asserted, and therefore, the motives have not become immaterial. This case then becomes a purely classic case. 17 corporations merged into one corporation which seeks to deduct the loss of some of the predecessor corporations. Now, the pertinent statute, the case arises under the Internal Revenue Code of 1939, Section 23. "In computing that income, there shall be allowed as deductions, the net operating loss deduction computed under Section 122." Section 122, "If for any taxable year, the taxpayer has a net operating loss, such net operating loss shall be a net operating loss carry-over for each of the three succeeding taxable years." The question of the deductibility of the net operating loss in this case involves only the effect of the statutory merger of the 17 corporate -- component corporations on the carry-over of the loss of the three of them. No question is raised here on any other aspect of that deduction. Now, the statute which I have just quoted appears to mean clearly that the loss may be carried over. The only objection made to that result in this case is that petitioner has now constituted -- differs in some respect from the corporations which had the net operating losses and may pause only to note that the statute does not state any requirement if the person seeking the deduction must be the same person who suffered the loss. That the identification of the person entitled to the deduction was not a matter of primary concern to the drafters of the statute. They were considering the computation of net income and so expressed the definitions both of gross income and deductions. I passed that because this petitioner is entitled to the deduction because it is the same taxpayer, as that would suffer the loss.
Felix Frankfurter: So that's really the question.
Henry C. Lowenhaupt: That is the question.
Stanley Reed: Well I --
Henry C. Lowenhaupt: It may be --
Stanley Reed: -- I thought you said it was a new corporation. It's formed to take over the 17.
Henry C. Lowenhaupt: No. It was the surviving corporation in a merger of the 17.
Stanley Reed: There was -- there was -- created the new corporation.
Henry C. Lowenhaupt: The statutes of Missouri and Illinois, which were involved in this case and which are set out in the briefs, provide that any two or more corporations may merge into one corporation by articles of merger which shall designate which one of them is the surviving corporation and that that one so designated shall survive with all the rights, powers, duties, liabilities and so forth, of the component corporations except it's limited in the --
Stanley Reed: Then -- then I misunderstood that there was not a new corporation created after the -- or for the merger.
Henry C. Lowenhaupt: No, there was not a new corporation.
Stanley Reed: It was a consolidation of those that -- that had existed, four into one.
Henry C. Lowenhaupt: That's right. A merger --
Felix Frankfurter: I thought -- was it absorption really.
Henry C. Lowenhaupt: Merger is the technical word of the statute, all became one.
Felix Frankfurter: (Voice Overlap) consolidate -- it wasn't consolidated.
Henry C. Lowenhaupt: It was merger.
Felix Frankfurter: All right.
Henry C. Lowenhaupt: Looked on as if two streams has flowed together forming one stream.
Felix Frankfurter: Main stream.
Henry C. Lowenhaupt: The following stream includes all the pre-disaster streams.
William J. Brennan, Jr.: Which was the survivor, the management corporation?
Henry C. Lowenhaupt: The management corporation was selected as that which should survive. Now, the consideration of the question whether or not the corporation surviving the merger may have the benefit of net operating loss carry-over, may be approached on either of two basis, both lead to the same conclusion. First, we may address ourselves to the exact technical language and requirements of the statute and the authorities under that statute. It will have been noted that -- from the quotation of the statute that a deduction is allowed if the taxpayer suffers a loss. Petitioner, we assert, as the same taxpayer as its component corporations. It owes their taxes. The pertinent corporation statutes which have been quoted from Missouri and Illinois are in this respect identical with the statutes of almost every other State. They provide for this continuity. Now then, three taxpayers, three corporations, three accounting units suffer losses in 1948 and 1949. The statutes says that -- that these losses shall be carry-overs. For whom shall they be carry-overs? The answer, for petitioner, because there is no other person that can be suggested who succeeds to these carry-overs along with all the assets, liabilities, every other characteristic of its component corporation. Now, that's the result of the statutes of Missouri, Illinois, the state statutes. An inquiry may be addressed as to whether or not the state statutes are controlling in this matter. The answer to that inquiry is that they are, and the reason that the Internal Revenue Code expressly so provides. It does so in its definition of corporation that a corporation shall include associations, trusts and so forth. Of course, we all know that the word corporation includes also any organization to which a charter is granted under state law that the word corporation is not limited to an association, trust or partnership. That one individual may own all the shares of -- of a corporation. In which case, there would be no association, no trust, no partnership. Nevertheless, there is a corporation. So that by definition, the Internal Revenue Code adopts the state law for the determination of the existence of a corporation. Having adopted that state law for the determination of existence, it's a logical necessity that the same law be looked to, to determine continuity. Continuity, existence, corporate entity, corporate identity just aren't separable. They mean the same thing. Then further, taking this particular case to determine the application of state law, we find that without the application of state law, there is no basis for the very beginning statement in this case. I stated that prior to 1949, there were 17 corporations. The only reason that there were 17 corporations was that there were 17 charters issued by the States of Missouri and the State of Illinois. If we attempt to disregard the laws of the various states in determining corporate existence, corporate separateness, corporate continuity, corporate entity, we must find in this case that prior to 1949, there was only one corporation, that there was no merger. 17 corporations existed only because there were 17 charters and the state law recognized 17 separate accounting units, entity corporations. Now, this is -- has been the accepted practice of Treasury Department, of all administrative agencies since the beginning of the income tax law that any entity with a charter, organization chartered by the State as a corporation ,is necessarily a corporation regardless of whether or not it's in association, trust or partnership. So, we have the state law to -- to look to. We have it adopted into the Internal Revenue Code. We have the state law providing the kind of succession which here occurred, the kind of continuity of existence looking to the state law for the determination of existence and entity. We must also look there for the determination of continuity and identity. Now, we may look for a moment to the decisions pertinent to this question, particularly, the case of Helvering versus Metropolitan Edison Company.
Stanley Reed: Which -- which -- before we get into that, which -- which State was the surviving corporation? Missouri or --
Henry C. Lowenhaupt: The surviving corporation was a Missouri corporation.
Stanley Reed: And there's -- there's no question about the validity of the merger into it?
Henry C. Lowenhaupt: No question has ever been raised. The statutes of Missouri and Illinois are identical in their provisions for merger, both being copies from the Delaware statute.
Stanley Reed: Yet, the Illinois corporations left Illinois when they were merged into the (Voice Overlap) --
Henry C. Lowenhaupt: That's right. And the Missouri corporation was authorized to do business in Illinois. Referring first to Helvering versus Metropolitan Edison Company case, that case involved a corporation which they issued bonds for less than far, amortize the discount. Before the bonds matured, it was merged with another corporation, questioned whether or not the other corporation, by virtue of the statutory merger, could continue the amortization answered in the affirmative. The other case in this Court which touches upon the question is possibly New Colonial Ice Company, a case of a reorganization different from a merger. It was a case in which the Colonial Ice Company incurred liabilities, found difficulty under its corporate charter, transferred all its assets to a new corporation in consideration of which the stock of the new corporation was issued to shareholders, creditors and others of old corporation. Without any exact or detailed study of whether or not a reorganization had occurred, it was held that the losses of the old corporation could not be carried forward to the new corporation. It was pointed out by the Court that the old corporation kept its charter, continued to exist. Now then, if both New Colonial Ice Company and the more recent Metropolitan Edison decision are to be accepted as correct decisions, the problem is to find the material distinction between the two cases. The difference repeatedly pointed out both in the lower courts and the Treasury Department rulings and the administrative interpretations, is that one case involved a reorganization which was not a merger, the New Colonial Ice case. The other case, Metropolitan Edison involved a reorganization which was a merger. That distinction may be accepted. Without that distinction, the cases are in conflict. The distinction has been accepted by Congress. The quotations from Congress have been set out in the briefs. The distinction has now been abolished by the Internal Revenue Code of 1954. It was described as an over technical distinction. The distinction is made. If it's accepted, it follows that in this case since a merger occurred, the loss may be carried -- carried forward under the doctrine of Metropolitan Edison. In another case, if it was a reorganization of a different kind, then the carry-forward might not be allowable. But to approach the question more generally in terms of reorganization, it may be urged that there's no real distinction between a merger and another reorganization. In many cases, the same -- the -- a different technique may be used to accomplish the same end. This certainly is the reasoning which appealed to Congress when it enacted the Revenue Code of 1954. And it may possibly be that the distinction has no materiality to it. If that be so, then the New Colonial Ice Company case was possibly wrongly decided. Nevertheless, it would appear that the Metropolitan Edison case expresses the preferable doctrine that if New Colonial is to be abandoned, the proper rule should be that upon succession in a reorganization, the net operating loss suffered by a predecessor corporation opt to be allowed as a carry over to its successor in a reorganization whether or not it's a component corporation. Now, I may assume here that in this regard, notwithstanding the authorities are all to the contrary, no difference exists between a merger in any other kind of reorganization. We know the substantial purposes of Congress in the allowance of these carry-overs. The substantial purpose is to alleviate the hardships of water-tight annual accounting periods. These annual accounting periods have as their only justification, the administrative expediency. Where it is consistent with administrative expediency to allow the carry forward, Congress has intended to do it. Congress has shown, by its language, that its concern is less with who may carry over the loss, who may take the loss, and with the substantial proposition that the loss may be carried forward, it so expressed. Previous statutes have reiterated the word taxpayer. Words have been changed one way or another but without any apparent intention to make a substantial change in the meaning of the statute. The fundamental injunction of the statute is the net loss shall be a carry-over. Now, there is no doubt that this petitioner is poor by reason of the losses which its predecessor suffered, that no other person is, no independent corporation exist. There can be only one surviving corporation in a merger. This corporation is liable for the debts of its predecessor, not by contract, by mere operation of law, by succession, by continuity. This corporation merely continues the businesses, the operations, the assets, all the elements of its predecessors. Now, to be sure if we go into the meaning of reorganization, why the reorganization sections were passed, you find this history which I may state briefly that the original Revenue Act contained no provision whatsoever or nonrecognition of gain upon exchanges. The Courts commenced working out rules to govern the determination of whether or not upon a particular exchange, there was a disposition of an asset or mere continuity of ownership in a different form contrasting termination continuity. Now, that was a very difficult question, the variety of transactions, infinite. Before very long, Congress came to the aid of the courts and enacted definitions of the kinds of exchanges which resulted in continuity as compared to the kinds of exchanges which were -- resulted in termination of an interest. Now, it may well be that the courts, possibly under the leadership of Mr. Justice McReynolds, were over anxious to help as to accept this exact statutory help which Congress had given them to apply the words of the reorganization without any thought as to the reasoning that went behind and if a transaction fit the form of the statute to declare the reorganization. This was the state of the law when the New Colonial Ice Company case was decided. There was no consideration given to the reason for the rules on reorganization, rather, if the form of an exchange fit the description of the statute, that was a reorganization.
Stanley Reed: What -- what became of the older corporation in the -- in the Colonial Ice case?
Henry C. Lowenhaupt: It continued to exist.
Stanley Reed: Just as a shell?
Henry C. Lowenhaupt: As a shell probably and conducted no business.
Stanley Reed: That means it was not dissolved?
Henry C. Lowenhaupt: It was not dissolved. The Court adverts to that fact. Now, the rule that in order for reorganization to exist, there must be a substantial continuity. It was read into the statute and enunciated clearly, given expression for the first time in Gregory versus Helvering, decided about a year later than the New Colonial Ice decision. The Metropolitan Edison case was decided on the heels of Gregory versus Helvering. So that reading the decisions and the purposes of the statute together, what we find is that after the decision in the New Colonial case, this Court came to a realization that in order for a reorganization to occur, there must be continuity. It's so held in the Metropolitan Edison case, after the decision in Gregory versus Helvering, in which that rule had first gained expression. Now then, if continuity exist, identity must exist. The two words mean the same. If something continuous, it's the same as that which previously existed to distinguish between continuity and continued identity. It doesn't appeal to the mind. Now, this is the background of the Metropolitan Edison case. It represents the current trend of decision with reference to reorganization, that reorganization that presents continuity, continuity represents identity.
Speaker: Are you suggesting -- I just want to make sure I follow you, that if you wipeout the somewhat artificial test between the merger and other forms of reorganization and look at it in the more realistic ways to whether that is continuity, is that your suggestion as to the basic test that's --
Henry C. Lowenhaupt: Yes.
Speaker: involved.
Henry C. Lowenhaupt: Yes.
Speaker: Well, that leads me to ask this question then. I take it, as I understand the situation, before the merger of the 16 corporations, the three corporations has had not net operating losses, could not have taken any net operating loss deduction because of their -- they had no income.
Henry C. Lowenhaupt: If they had had income in succeeding years, of course they could have.
Speaker: Well, yes, but as of the year prior to the merger, there wasn't any tax benefit that would accrue to them.
Henry C. Lowenhaupt: There's no tax benefits.
Speaker: Therefore, when you think of it in terms of continuity, is it not a fact that as a result of the merger, there was a net operating loss deduction, a tax benefit that came into being as a result of the merger which did not exist before. And my question is whether that doesn't break the chain of continuity?
Henry C. Lowenhaupt: At the time of the merger, it could not be known whether or not the three businesses, three locations which has operated at loss in previous years would operate at a net profit in the succeeding years. Certainly, it was the hope of any businessman that those locations would show a profit, otherwise, they would have been closed. So that whether or not that net operating loss would have done any good would depend on circumstances which could not possibly be known. On July 31, 1949, when the merger occurred. It was the succeeding years which gave rise to the source of benefit, facts unknown at the time of merger. The carry forward existed, whether or not it would do any benefit -- accomplish any benefit, must depend on the profit picture in the succeeding years.
Speaker: But wasn't the -- didn't those three units continue to suffer losses during the succeeding years?
Henry C. Lowenhaupt: The fact is that they did suffer loss. That loss may result from some extent to allocation of overhead, similar accounting devices which are of questionable reality. The business as a whole, all the retail locations together operated comfortably after the merger.
Speaker: But what was bothering me was this, that if you take the continuity test and you answered that as of the time of the merger, you couldn't foresee what that operation should be in future years. In fact, in future years, the operation has altered, there's a loss of these three stores with that singly. And therefore, doesn't it remain true that the tax benefit came into -- came into being, came into existence only as a result of the merger?
Henry C. Lowenhaupt: To an extent, that may be true. The profits of the other corporations came into the picture. Now then, if we're approaching this on a substantial ground, it would seem improvident to reach one rule if the loss corporation were the surviving corporation. And another rule, if a different component corporation were the surviving corporation. The implication of the statutes of both Missouri and Illinois is that the corporate existence of all corporations continues in the merged corporation. So that approaching the question substantially, what ought to be done as a matter of economic substance, no distinction ought to be made based on which of the corporations is named as the surviving corporation. That is only a question of draftsmanship. It makes no difference other than what words you write in the paper you file with the Secretary of State.
Stanley Reed: What was the fiscal year? Did he -- all of these corporations --
Henry C. Lowenhaupt: All of the corporations had a fiscal year ending, July 31st.
Stanley Reed: So, this is at the end of the fiscal year when the results were known for the preceding year?
Henry C. Lowenhaupt: The merger occurred as of July 31st, 1949.
Stanley Reed: As of the end of the fiscal year for all?
Henry C. Lowenhaupt: Yes.
Hugo L. Black: Whatever -- whatever rules you adopt or whatever basis you put it on, as I gather from your answers, a merger of this kind would result either in a tax advantage to the merged company or to a tax disadvantage to the merged company. It would not remain the same if there was some losses, losses in some of the merged companies and gains on the others.
Henry C. Lowenhaupt: It would depend on subsequent events if those --
Hugo L. Black: Well, I was -- I'm -- I'm talking about -- but could -- could -- is it possible that if you have 10 corporations or 16 or whatever it is, and you have four of them that have losses and the rest have gains. Is it possible to merge that in such a way that the tax situation wouldn't be changed over -- from what it had -- would have been had they remained unmerged?
Henry C. Lowenhaupt: No, the merger must -- shorter filing consolidated returns.
Hugo L. Black: So, your argument -- your argument means if they've adapted and maybe it's right, that -- by a merger such as you had here, the -- if the -- shows to be done, there can be a tax advantage result -- has to be a tax advantage or tax disadvantage result --
Henry C. Lowenhaupt: Now, in any particular situation --
Hugo L. Black: -- whether with some gains and some losses among the companies.
Henry C. Lowenhaupt: Yes. In the particular situation, the tax disadvantage would far outweigh any tax advantage gained in this situation. In as much as with 17 separate corporations, there were 17 exemptions from surtax of $25,000 each. By virtue of the merger, there was only one. Now, that comes to some $400,000 exempt from surtax prior to the merger with $25,000 exempt from surtax subsequent to the merger.
Hugo L. Black: Now, absent of merger. Let's suppose, now absent the merger here, the tax would remain precisely as Congress had -- wouldn't it, could it not? The results would be the same that Congress had provided for. Forget there's a merger.
Henry C. Lowenhaupt: Yes.
Hugo L. Black: You had -- had no merger and then you could administer the tax law in accordance with the provision that -- as the way they're written, but the other permits the merger to alter the tax results.
Henry C. Lowenhaupt: That's right. Now then, it's unnecessary in this case to decide that the New Colonial decision is wrong, but this case follows the Metropolitan decision. Nevertheless, the New Colonial case, as Congress has stated, should at least be confined to its own facts. Let me read the statement from the congressional committee reports. "Your Committee agrees that whether or not the items carry-over should be based upon economic realities rather than upon such artificialities as the legal form of the reorganization. The new rules, speaking of the rules of the 1954 Code, enable the successor corporation to step into the tax dues of its predecessor corporation without necessarily conforming to artificial legal requirements which now exist under court-made law," speaking of the distinction made between Metropolitan Edison and New Colonial Ice. Congressional reports have used the same reference to pension trust deductions and numerous other kinds of deductions which may be carried forward. They indicate that all these tax credits are to be considered in the same light. In 1954, they rejected the distinction which has been made between New Colonial and Metropolitan Edison, recognized as its -- this distinction as existing prior to 1954. Whether or not this distinction can coexist with the doctrine of Gregory versus Helvering, that reorganization is a substantial thing involving continuity of the business, need not be decided here. The reason is that this case involves a statutory merger. Petitioner is entitled to the credit claim under the doctrine of the Metropolitan case, whether or not the doctrine of New Colonial stands. But at this point, to extend the doctrine of New Colonial, contrary to the -- to the settled understanding of Congress, to the expressions of the courts, the Treasury Department, the understanding of the Bar would be a rather pitiful effort against a rather broad current of judicial decision, judicial interpretation on the nature of a merger and what a merger is. For these reasons, it's submitted that the carry-forward should be allowed. I'll reserve the rest of the time for (Inaudible) to answer.
Earl Warren: Mr. Stull.
John N. Stull: May it please the Court. Mr. Justice Harlan and Mr. Justice Black have succinctly stated the Government's difficulty with this case. That is that in our view, the taxpayer's position boils down to a contention that losses realized by three separate businesses that never could, up to and including the year of the merger here under consideration, all set the income or reduce the taxes of those businesses, can as a result of the -- this merger suddenly all set to fit the income and reduce the taxes of 14 other businesses. Our position is that if this is a correct result, it's certainly one that should be set forth in the statute. We don't think it is. Now, I'd like to go back for just a second over the facts of this case since they were very briefly stated. The owners of these 16 retail stores and the one store supplying management to it chose to operate in the corporate form. They could have chosen to do it through the medium of one corporation with 17 separate divisions. They did not do this. And if they had done it, they -- they would have been able to offset the losses of these ailing corporations against the profits of the good corporations and this case never would have arisen. But they chose to operate this business through the medium of 13 Missouri corporations and four Illinois corporations. Our counsel has stated that there would be some advantages to doing this. They certainly wouldn't have done it if there hadn't been advantages such as limiting liability, possibly reducing state franchise taxes. And certainly, at the inception of businesses, it's well if it's possible to be able to chop them up into as many segments as possible for federal income tax purposes. In the years here in consideration, the lowest corporate rates were imposed upon net incomes below $25,000. Somewhat higher rates were imposed on incomes from $25,000 to $50,000 and the highest rates were reserved for incomes in excess of $50,000.
William J. Brennan, Jr.: Over what --
John N. Stull: Those --
William J. Brennan, Jr.: -- what years were these companies are --
John N. Stull: Pardon me sir?
William J. Brennan, Jr.: Over what years were these companies organized?
John N. Stull: They started in 1946 and I believe the last one was 1948, sir.
William J. Brennan, Jr.: Is your statement applicable to both of the years?
John N. Stull: Yes, sir. Later on, there was a change in that, but this -- it still is in effect that corporations within counts below $25,000 pay less tax. So, it still is advantageous to chop up your businesses into small segments. Now, even though they chose this form for whatever advantages they realized or hoped to realize, they still could have avoided this situation by filing a consolidated federal income tax return which would have in effect ignored the separate corporate entities. But of course, that has a disadvantage of a 2% additional surtax, and also, it has the disadvantage of giving you only one net income and loses the advantage of splitting up those incomes for the lower tax rates. Now, three of these corporations, separate losses, two were Illinois corporations and one was a Missouri corporation. These losses qualified under the statute as net operating losses which could be carried forward to offset the income of the corporations for the next three years. I don't believe that counsel meant to make any contention that these corporations should be ignored for federal income tax purposes so that the losses of the three ailing businesses prior to the merger could have offset the income from the other businesses prior to the merger. On August 1, 1949, these corporations went through a merger under the state laws of Missouri and Illinois. As a result of that merger, the resulting corporation was a Missouri corporation. It had its name changed. It changed and increased its authorized shares and it extended its business purposes. And the taxpayer now says, that as a result of complying with these state laws, the pre-merger losses two separate Illinois corporations and one separate Missouri corporation, can now offset the post-merger profits of a resulting Missouri corporation.
Speaker: In what respect, Mr. Stull, were the business purposes of the resulting corporation changed or added to the use?
John N. Stull: There is nothing in the record on that, sir. The only thing that's in the record is that they were extended. I don't believe that that is particularly important to the Government's position in this case.
Speaker: Well, you mentioned it. That's the reason I --
John N. Stull: Well, it's just -- I have mentioned it to show that it wasn't exactly the same thing that they started off with before from the corporate entity view.
Speaker: So, I understood that the original before the merger, the -- what was then the management company had in its charter powers to engage in operation.
John N. Stull: Yes, sir.
Speaker: And the only result of the merger was to bring those powers into being and became an operating company instead of a management company, is that right?
John N. Stull: Yes, sir, except that it is stipulated that there were certain changes. How extensive they were, we have no way of knowing. Now, these -- the taxpayer's position in this case is that the resulting Missouri corporation now can deduct from the profits of these 14 other businesses, the losses of the three ailing businesses which would suffer prior to the merger, which certainly couldn't have been deducted from them before. Now, while counsel below, somewhat, the separate accounting theory after the merger, it is stipulated that separate accounting showed that those three locations as he calls them businesses, I think they were, still suffered losses after the merger. So that this post -- these pre-merger losses never could, up to and including this year, have all set any income or reduced any tax but for this merger. Now, the basis of taxpayer's position here seems --
Stanley Reed: But do you think that affects your argument in any way?
John N. Stull: I certainly do, sir, because we have losses that never could have been used if these corporations had continued the --
Stanley Reed: That's --
John N. Stull: -- way they were before.
Stanley Reed: -- that's a purely a business accident, isn't it? Evidently, they expected to make a profit out of it or as counsel preceding have said they wouldn't have continued those locations.
John N. Stull: Well, they certainly didn't drop them, sir, even though they did realize losses.
William J. Brennan, Jr.: Yes.
John N. Stull: And it maybe that they -- it maybe in the next 20 years they might have made a profit that could carry forward to going through.
William J. Brennan, Jr.: But they didn't -- they didn't continue the business so as to get tax deduction, I take it.
John N. Stull: Well, it's perfectly possible that they did, sir. This -- this whole thing opens up a -- failed a tax avoidance in our view. That is that you can get two shots of the apple here by using -- if this result is a correct one. Somebody starts up a new business. Let's take the operating loss carry-over provisions of -- few years later to accentuate it. Those loss provisions gave you five years forward and one year back for seven years' pay. You can start up your business when you expect that some of the end segments of this business may realize losses. In any event, you're going to keep them small so that you can get the event of the lower surtax. But you know that if at the end of five years or just before the end of five years, any of these other businesses have made such losses that it's advantageous to put together, you have nothing to lose, you could just put them together. And these losses will offset the income just as they would have if you had operated under the -- under one single corporation from the very beginning.
Stanley Reed: And -- and you think that's objection?
John N. Stull: Yes, sir, we do. We think that, that should only be allowed if it's clearly allowed by the federal tax statute.
Stanley Reed: Even though the same people only take all the risks in all the different corporations?
John N. Stull: Yes, sir. These are separate corporate entities. We cannot look through them to the people back at it. They pay their own taxes. They are able to store up income in them. If they had wanted to worry about the people behind it, they could have operated in partnership form, for example. Then, this case never would have arisen because there would have only been one income for this -- this partnership.
William J. Brennan, Jr.: Does it make any difference that all of the -- all of the corporations sold the same product?
John N. Stull: I think that that has some relevancy in this case, but I can't see that the business of a Missouri corporation which is now operating 16 different retail outlets spread throughout Illinois and Missouri, and also, furnishing management to them is the same business as a former Missouri corporation or as the old Missouri corporation which was only in Missouri and was only furnishing management services to the other corporations. I think there's been a complete change in business by that corporation even though --
William J. Brennan, Jr.: Would your -- would yours be a stronger case do you think if each of these 16 constituent companies had been in a different business?
John N. Stull: That's -- that's really difficult to say. I think that what the businesses are doesn't make any difference. In this particular case, I think that the fact that they were similar is not material here. I don't think we would have much of a stronger case except as it might show tax avoidance if they were -- even further if they were trying to put two things -- things together.
William J. Brennan, Jr.: But that's not suggested here.
John N. Stull: I think that these results in a tax avoidance scheme, Your Honor, as I've said before about giving the taxpayer two shots at this thing.
Felix Frankfurter: But if it merely -- it wasn't tax avoidance they are entitled to avoid if --
John N. Stull: Only if the statute -- the federal income tax law sold out, sir.
Felix Frankfurter: It merely talk about your words. If it's an avoidance then it's on the right side of the line?
John N. Stull: There's no question of relation here.
Felix Frankfurter: All right.
Hugo L. Black: Suppose there had been seven --
Speaker: Put -- put -- putting in a --
Hugo L. Black: Suppose there had been 17 individuals who had been doing business for two years, some have been in losses and carry-over and so forth. When they organized, they decided to put all of them in one corporation, what would have been the result of that?
John N. Stull: No question about that, sir. There would have been no carry-over.
Hugo L. Black: Why?
John N. Stull: Because there is an entirely different taxable entity. There is now instead of 17 individuals --
Hugo L. Black: (Voice Overlap) there were taxable entities in there, aren't they?
John N. Stull: Pardon me sir?
Hugo L. Black: I thought they were entirely different taxable income?
John N. Stull: That's what we say.
Hugo L. Black: That's the question --
John N. Stull: That's our position.
Hugo L. Black: Well, I had suppose -- I thought there was a -- the court ruled an opinion some years ago to the effect because as they chose to do business, this corporate entity, and get tax to corporate entities, they were taxed as corporate entities.
John N. Stull: Now, they -- they have to take the disabilities to go along with it.
Hugo L. Black: Higgins against Smith, as I recall it, was the case that's in there, something like that. Did you cite that?
John N. Stull: Yes, sir. I think that's cited in our brief.
Felix Frankfurter: Well, this isn't the question -- this -- our problem is fully unrelated to the legitimacy. They're doing business in 17 corporation. That's -- that's -- that isn't a -- have something to do with that?
John N. Stull: It's perfectly all right, sir, for them to do business in 17 corporations.
Felix Frankfurter: But this -- this 17 cooperation -- and you say they did business in 17 corporations and when they shrink at their own, it isn't the same thing?
John N. Stull: That's right. Exactly, sir.
Hugo L. Black: And you say that the law doesn't allow 17 individuals to shrink their tax -- taxability into one corporation?
John N. Stull: No, sir. You can't even -- even if you and I should go into a partnership, our three partnership losses wouldn't be carried over to partnerships, so far as I know. That, it would -- it would have that effect. I take that back, sir. It would have that effect, because the individual has his own losses which should be offset against his other business income in the future year. But when you interject the corporate entity, then -- then you can't go across the corporate line with net operating losses. I don't think you could say that it was the same taxpayer, you cannot look through that entity.
Stanley Reed: But you can go from an individual to a partnership?
John N. Stull: Yes, sir, because the federal income tax laws look through a partnership --
Stanley Reed: But it looks through it.
John N. Stull: Yes, sir. It's not a taxable --
Stanley Reed: Well, why -- why did you say --
Felix Frankfurter: But it isn't referred -- doesn't regard it as an entity.
John N. Stull: Well, it's a tax-computing entity --
Felix Frankfurter: Well that --
John N. Stull: -- but it is not a taxable entity, sir.
Felix Frankfurter: Taxable.
William J. Brennan, Jr.: Did you say that except for charter amendments, the surviving corporation could not have been an operating company?
John N. Stull: No, sir. I don't know that. I don't believe that's so.
William J. Brennan, Jr.: Do you mean that if it could have operated --
John N. Stull: I think that it did have the power --
William J. Brennan, Jr.: It did.
John N. Stull: -- to do this prior to the merger. Yes, sir.
Stanley Reed: As I understand it, the operating company was chosen as the --
John N. Stull: No, the management company, sir.
Stanley Reed: Yes, the management company --
John N. Stull: Yes, sir.
Stanley Reed: -- were all the same thing to me. Is there any difference between the operating and the management?
John N. Stull: Well, I think that --
Stanley Reed: Based on how you use the word "operating" I suppose?
John N. Stull: Yes, sir.
Stanley Reed: But anyway, it -- it continued.
John N. Stull: Yes, sir.
Stanley Reed: -- to -- to (Voice Overlap) --
John N. Stull: Well, it was the resulting corporation from this merger. Yes, sir.
Stanley Reed: And had been before.
John N. Stull: And had been in existence before --
Stanley Reed: Before, and what are the --
John N. Stull: -- with -- with some minor changes.
Stanley Reed: And when -- and the assets in the business and the others simply passed it to them by merger. Now, what I'm coming to, is there a provision in the tax laws in regard to the effect of mergers not -- not related to the carry-over but as allowing mergers?
John N. Stull: Yes, sir. The tax law recognizes that you can put together two corporations by statutory merger where that's allowed of course by the States --
Stanley Reed: By the States.
John N. Stull: -- without imposing income tax liability on either the corporations or on the shareholders who make exchanges. But there is no provision saying that you can carry over net operating loss after a merger.
Harold Burton: Your position is, isn't it that even though --
Stanley Reed: Unless -- unless by this provision here where -- unless if you had a continuous existence of the two or the 16 corporations here then -- then it would apply.
John N. Stull: Then they could have carried forward the losses to offset against their own income.
Stanley Reed: Well, that's what they're trying to do here as I understand it.
John N. Stull: They're trying to offset the losses of these -- these pre-merger losses against in effect income realized after the merger by what we still -- what we say is an entirely different corporation. This resulting corporation derived from, the businesses is carried on by the 14 other corporations. They were profitable both before and after the merger.
Stanley Reed: But when they merged, I don't just see why one continues and one not because of the names that's chosen or -- or all the assets, all the liabilities of the old corporation passed that had been used and they don't pass it by sale but by merger. Doesn't everyone of those 17 continue as a part of the new merger?
John N. Stull: Well, perhaps under the state law, they do, sir. But I don't think that that has anything to do with the federal income tax consequences of the merger.
Felix Frankfurter: And --
John N. Stull: (Voice Overlap) --
Stanley Reed: Well, in affects on whether there are continues existence of the former 16, doesn't it?
John N. Stull: It -- well, it carries on the businesses formerly carried on by the others.
Stanley Reed: Well, I should think it's the corporation itself.
John N. Stull: I suppose there is --
Stanley Reed: Does the -- doesn't it depend on whether the pre-existing corporations continue with the liability and responsibility after the merger?
John N. Stull: Because one continue, sir.
Stanley Reed: If the 16 corporations that were merged into the new one, doesn't the new one assume all the liabilities and is liable (Voice Overlap) --
John N. Stull: Under state law, yes sir.
Stanley Reed: -- to the others?
John N. Stull: Yes, sir, under state law.
Stanley Reed: But why don't the 16 continue with their liabilities and obligations continues?
John N. Stull: Well, because they've -- supposedly under the state law, they are now identified with one resulting corporation --
Stanley Reed: Yes.
John N. Stull: -- that they do not survive as particular state entities.
Hugo L. Black: They don't survive under the name of A, but they do survive under the name of G or --
John N. Stull: That's what the state law says. Yes, sir.
Harold Burton: You can concede, can you not, that they do continue as the same corporation but still they're not the same taxpayer for the purposes of the carry-over?
John N. Stull: Well, we say that the same -- the way they continue as the same corporation under the state law, but they don't continue as the same corporation or as the same taxpayer under Section 122 under the federal income tax laws.
Hugo L. Black: Can the state law continue their tax obligations or do away with their tax obligations?
John N. Stull: Well, I --
Hugo L. Black: I could understand how the state law can fix the contract between private partners, say that if you merge, you're not going to be allowed to defeat your obligations nor must you to take on more. You continue the old just as much as you did before. You can get paid as much as you could before in existing obligations between private partners. But does that result tax-wise here?
John N. Stull: No, sir.
Hugo L. Black: If you adopt the conceptualistic idea that these 16 corporations that have somehow been -- this used to be and now still existing in some way and the concepts are divine. But do they continue as they would as between private contract, private contracts that will had to be paid in full? But would the Government get its full tax it would have gotten at these conceptualistic corporations not changed there, somehow the invisibility or visibility?
John N. Stull: Well, the taxpayer says that we won't and we say that we will get -- that we should get the full tax.
Hugo L. Black: Well, that's right. Then, what -- the effect of this would be that the Government will not -- that these corporations will not have to -- do not continue with the same obligations that they had before and now with the same benefit. Because when they merged, that changes the tax situation and changes the obligation, but that wouldn't happen with the reference to the -- the part of the activities of the state governments, would it, as between private partners? The obligations would neither be increased, nor -- or -- nor diminished. But here, you would change the obligation as between -- after this occurred according to the arguments made here.
John N. Stull: Yes, sir. I think that --
Stanley Reed: So, by the -- so by that merger, you destroy the opportunity of the -- those that had a loss before to ever regain anything from it.
John N. Stull: That's correct, sir.
Hugo L. Black: You mean, you do with the Government. You do what they did? They choose to give it up. I -- I don't quite understand where -- where do they have that you do it as the Government.
John N. Stull: We're -- we're destroying there -- we say that the authority can carry forward that merger that those were pre-merger losses is destroyed by the merger.
Hugo L. Black: You say that the -- you say that the law gives corporation as such the rights within their own area of what they owe and what they don't owe and so forth, state certain tax deductions, and they can't change it by merging three or four into one.
John N. Stull: Yes, sir, exactly.
William O. Douglas: You would be the first one, add together surviving corporations, surviving whether the tax -- taxes (Inaudible) other 15.
John N. Stull: That -- that is correct because it's their liability. I think that state law would say that it's a liability like any other debt, and I think that we could collect from them. Yes, sir.
William J. Brennan, Jr.: Well, tell me. I -- I had the impression as to where there were statutory mergers. I'm speaking now -- but we understand generally as merger is distinguished to other forms, consolidation and the like, and the big fish swallows the small one. After that, you have to look to the big fish to collect anything. Is that right?
John N. Stull: That's correct, sir.
William J. Brennan, Jr.: The small ones disappeared. Well, why shouldn't that carry with it the right of the big fish to take on whatever the small one was allowed to have in way of the taxes?
John N. Stull: Well, because in the -- in the case of the tax liability, it's a question there of a debt that is owed by the resulting corporation because the losses that said, they have to take over all the assets and they have to assume all the liabilities. So, it's their debt that they are paying. And it's they -- they that we can go after in that particular case. But that doesn't say that a pre-merger loss carries over because that is a loss of a corporation which no longer exists as a corporation. It only exists under the state law as a part of the resulting corporation.
William O. Douglas: When I said this tax is the tax asset.
John N. Stull: Yes, sir.
Stanley Reed: There's -- there's no legislative history on this merger of aspect exactly?
John N. Stull: Sir, I've come to a legislative history of this -- of the net operating loss, carry-forward and carry-back provisions but I haven't found anything that's particularly helpful. I haven't been able to find anything in the legislative history that indicates that they ever wanted to allow this situation. And certainly, nothing that indicates that they wanted to allow in the effect pulling losses the way it's happening here, pulling the losses and the gains of corporations as a result of the carry-overs. That was never meant.
Stanley Reed: But, since the -- since the days of Gregory White versus Helvering or Helvering versus Gregory, I forgot which, you had these merger provisions in other phases have to, so to speak.
John N. Stull: The merger provisions have been in the tax laws for a long time. I know as long -- goes from 1921, sir. And the -- the only two cases on it that I know decided by this Court are the New Colonial Ice Company case and the Metropolitan Edison Company case which we feel are entirely distinguishable. We think the Metropolitan Edison Company case is distinguishable and it just never decided this question. Because in that case, that had to do with discount on bonds issued by the corporation which is in effect an interest expense because the corporation of course has to eventually redeem to that power. So, they allow an amortization derivable deduction. After the merger, the corporation resulting from that merger has the liability to repay those bonds, and it's going to -- to suffer this loss. So, we say that under the Metropolitan Edison Company case that if a corporation has a post-merger expense even though it may --
William J. Brennan, Jr.: What kind of expense?
John N. Stull: A post-merger expense, even though it may have originated with some transaction that took place pre-merger that is perfectly all right for it to take a deduction and because it its liability and its expense that's being paid. Now, the Metropolitan Edison Company case and distinguished -- being distinguished on that ground from the New Colonial Ice Company case, I must admit that we're not completely happy with the Metropolitan Edison case or rather than the Government's conduct in it because in that case, it was conceded that if a statutory merger took place that the deduction would have been allowed. We don't know quite why that was done on brief and unfortunately, everybody connected without debts and we can't find out. But we do think that probably, it was to win that case if they thought that there was not a statutory merger in the case and since some of the lower courts had gone off on the distinction between statutory mergers and other mergers, they decided to follow that and win that particular case. Now, the result contended for by taxpayer here would, although it seems to be going further than any of the lower courts had gone in oral argument here, would result in these losses being allowable after a statutory merger but not after other mergers which are tax-free under the federal income tax laws. A few years ago of course, a lot of States didn't allow the mergers or perhaps they didn't allow a merger with a foreign corporation. So, the federal income tax law has a practical merger which is the same effect, it's a -- an exchange of stock for assets. And as I understand these lower court opinions in this -- on this ground, they wouldn't allow in that situation the carry-overs to go forward. They look at state law, and they'd say that if it's a statutory merger under the state law, it will allow to carry-forwards, but if it's a practical merger or the tax pre-liquidation of the subsidiary, we won't allow it. Now, that -- that seems to me that Congress usually tries to legislate uniformly throughout the States. And if the carry forward of a net operating loss is going to depend upon the particular state law, we think that it certainly should be clearly set forth in the statute and we will see if it is.
Felix Frankfurter: Did I understand you, Mr. Stull, to say that during the life of this marketable corporation, a consolidated income tax could have been filed.
John N. Stull: They could have incited to that, yes, sir.
Felix Frankfurter: Pardon me?
John N. Stull: Yes, sir.
Felix Frankfurter: In which the losses and the credits -- the losses and gains could have been offset and all these things could have been then claimed.
John N. Stull: Yes, sir.
Felix Frankfurter: Is that correct?
John N. Stull: That's correct, sir.
Felix Frankfurter: And they did not do that.
John N. Stull: They did not.
Felix Frankfurter: It's a part of individual reports with their individual gains and losses.
John N. Stull: They wanted to take the advantages of separate returns and separate corporations.
Felix Frankfurter: (Voice Overlap) I mean those incitements.
John N. Stull: Incitement.
William J. Brennan, Jr.: Well if the taxpayer prevails, do you see any particular loophole, would have assessed as tax consequence?
John N. Stull: Well, I do think that it's going to -- it may open up areas, other areas, Your Honor. And that if state law is to control in this situation. It seems to me that a lot of decisions of this Court have to be distinguished in a way I certainly can't do it and possibly overturn. It also seems to me -- well, to answer your question specifically, this -- this particular situation has been taken care of by Congress in the 1954 Code. Now, we know that there'll be problems that will arise in applying those provisions but this particular case here probably would not arise under the 1954 Code. So, the area of tax avoidance may be a limited one.
Speaker: Could I ask you a question that maybe --
John N. Stull: Yes, sir.
Speaker: -- a little extraneous but -- you're familiar with the Newmarket case --
John N. Stull: Yes, sir.
Speaker: -- in which the -- as the Chief Justice announces the brief today that was filed here in light of this. As you can -- are you familiar with the case?
John N. Stull: Yes, sir.
Speaker: Do you can see that the result of both these cases has to -- they have to stand up altogether.
John N. Stull: And they -- we have a -- there is a possible distinction between this case and the Newmarket case. In that -- you see, our basic argument here is that these losses can be used only by the taxpayer who suffered them. That has got to be the same taxpayer. Now, we say there are two facets in determining whether you have the same taxpayer. One is the entity, is it the same entity? Well, we say in this case that a surviving Missouri corporation isn't the same thing as all the rest of these Illinois and Missouri corporations. We also say in Newmarket that there, a Massachusetts corporation which was the old corporation is not the same taxable entity as a New Delaware corporation. Now, if it were the same entity, it seems to us that they've gone through an out of gesture and an expensive one in moving to Delaware because they said that the reason they moved was to prevent franchise, Massachusetts franchise tax on New York sales. Well, if they hadn't done anything, if they hadn't had any advantages from moving to Delaware, if they had the same corporation that they had before, it seems to me that they wouldn't have gotten out of franchise.
Speaker: Well, I don't want to argue -- I don't want to argue the Newmarket with you but I suggest --
John N. Stull: Well, sir --
Speaker: I suggest -- I say I don't want to argue Newmarket with you, but I suggest that as far as your continuity test is concerned which is your second facet, you had a quite a different problem in Newmarket than the one you have here.
John N. Stull: That it is correct, sir, because we can't argue with second problem.
Speaker: -- because the Newmarket simply change your domicile.
John N. Stull: The second problem to our argument is that it has carry on the same business. And we admit that in Newmarket, it is carrying on the same business.
Speaker: So, you have to rest, it seems to me, there and squarely on the proposition of the difference between a -- the different corporate entities --
John N. Stull: Yes, sir.
Speaker: -- technical corporate entity.
John N. Stull: May I point out that in Newmarket, there was a carry-back rather than a carry-forward.
Speaker: Yes and --
John N. Stull: -- and it's a little bit even more difficult for me to see how a loss of one corporation, the Delaware corporation, can be carried back and used to offset income in a year before that Delaware corporation was even in existence. I think I have only a few more points to make. I want to say that the legislative history, we think, whatever there is in it, is slightly helpful because there's no indication that in this situation would ever be -- a loss would be allowed to be carried over. We don't think that it ever was indicated that approving of losses would be allowed such as resulted here. Now, there has been mention made in the taxpayer's brief as to the administrative practice or the administrative practice admittedly has not been quite as clear as it might have been. However, there has never been any regulation or any ruling with the dignity of the treasury decision that was issued covering this situation. There is one pension trust ruling which deals with the carry over of past service credits which are funded and therefore deducted ratably over a period just like an amortized bond discount. We think that the rule there is exactly the same as the Metropolitan Edison Company case, that it is the liability of the resulting corporation and therefore, the deduction should be allowed. We haven't been treated too well by the lower courts in this situation. We lost in the Second Circuit with Judge Learned Hand dissenting in 1949 and no indication ever came out from the Treasury Department that they were going to follow that case and in fact, they kept on litigating it in the Tax Court and in these cases here. I think that probably, although I might say that we're not completely "fundless" before this Court, we do have the District Court and the Eighth Circuit of course, we have Judge Wyzanksi who was overruled by the First Circuit and we have the Tax Court on our side, and we have Judge Learned Hand dissenting in the Stanton Brewery Company case. I think that probably the distinction made by the courts and the point at which there is a departure between Newmarket, Gallo and this case and others is the emphasis put on state law by those courts. It's also probably an approach to the net operating loss carry-over provision. Now, we say that it is a deduction, that it is a short departure from the annual accounting periods, and that therefore, it should be construed now. Some of the lower courts seemed to feel that it is a relief provision and should be construed rather broadly. I think that is possibly that all I can get from the interpretation of the lower court, plus the fact that they think that the New Colonial case was -- might have been overruled or certainly is inapplicable after the Metropolitan Edison Company case which we don't think so at all. I can do now in part or in closing in reading part of the dissent from Judge Learned Hand's opinion which I think pretty well sums up our position here. He's talking about an excess profits tax credit carry-forward which in principle is the same as the net operating loss credit carry-forward here. And he says, “A statute so intricate and detailed such as this means little latitude for interpretation. Moreover, I do not think that it is more consistent with any declared purpose that I can find to extend the privilege to a -- of a carry-over to the taxpayer far. Indeed, as a decision cited in my brother's opinion show, privilege is closely akin on purpose to this are ordinary laws by transfers from one corporation to another. And the full of the transfer cannot be imported. We have no warrant for supposing that Congress in general regard such credits as parts of a universitas juris passing with the chattels, choses an action and the rest by a goodwill or trademarks.
Speaker: I'd like to ask you one question if I may, Mr. Stull, under your taxpayer theory, the first face to your argument. Take two corporations A and B, B has losses, net operating losses. If A merges into B under your theory, would the merged corporation be entitled to take the operating loss deduction?
John N. Stull: That is a question of form and I would have to answer that in the affirmative, except --
Speaker: And there would be --
John N. Stull: -- for -- for instance, if United States Steel merges into some small corporation with a couple of million dollars of losses --
Speaker: Alright. Yes, I'm not thinking about that.
John N. Stull: Yes, sir.
Speaker: So, your answer would be, they could say --
John N. Stull: We would say in that -- in that case that the form would control (Voice Overlap) --
Speaker: Well, I'm taking back the same situation. Reverse, B has the losses and it merges into A, could it take the -- A corporation take it?
John N. Stull: No, sir.
Speaker: It is not a pretty artificial kind of a concept to attribute to Congress?
John N. Stull: I don't think so, sir. I think that there has been a change of taxpayer in that case.
Speaker: Well, there's been a change of tax -- taxpayer because the lawyer could have paid for --
John N. Stull: Because the assets that produced those losses or the -- the losses are now coming over into another corporation to offset the income that is being realized from assets that had nothing to do with realizing those losses.
Speaker: That is simply because of the happenstance if the papers are going one way rather than the other.
John N. Stull: Well, unfortunately, sometimes those things happen in federal tax laws that you get stuck with these particular (Voice Overlap) --
Speaker: But you don't have to stand on that as I understand it. You -- you could say no, there's another question about here and absolutely there's a continuity, the continuity test to satisfy it too. And if the continuity test would satisfy, I would suppose you'd say that result in both cases ought to be the same.
John N. Stull: Well, I think that the continuity test of the surviving -- of their incorporation resulting from the merger in your first instance is met.
Speaker: Well, I mean in formal sense?
John N. Stull: The -- unless you have a -- an outstanding example like the one I gave.
Earl Warren: Mr. Armstrong.
Owen T. Armstrong Jr.: Mr. Chief Justice and Justices. I might, at the outset, review some of the questions that occurred as to the facts so as to clarify the matters. First, the question of when the corporations were organized in the first instance, appears at the record at page 14 and it appears that all of the 17, except one were organized on the same date, on January 2nd, 1946. And the 17th, one of the 16 operating corporations came in later about two years later. I think that may have affected the picture of the -- of the organization of the enterprise. Second question that was raised on the facts is the question of the change in the purposes of the corporation. I think it was indicated by counsel for the Government that he was aware of no material change in the charter and it is clear from the record at Page 15 that the management corporation, the petitioner, which is the surviving corporation, was authorized to engage in the business of selling of the commodity in question prior to the --
William J. Brennan, Jr.: But I gather it never actually operated the retail outlet until after the mergers, is that it?
Owen T. Armstrong Jr.: That is -- that is correct, Your Honor. Prior to that time, it simply acted as a supervisory corporation. Now, the question of the -- the basic problem here as -- as indicated maybe discussed in terms of the two facets to the Government's objection to the allowance of the carry-over in this case. The one facet has to do with the concept of the same taxpayer. The statute of course uses the expression "taxpayer" and the Government contends that petitioner is not the taxpayer who suffered any of the losses in question. Now, we take the position of that argument, falls as soon as we bring into the -- into the discussion the concept of statutory merger. We rely upon that as in itself answering the Government's objection that we do not have the same taxpayer here. Because once we bring into the discussion the concept of statutory merger, we bring in all that goes with it including the notion that in a merger, the corporate existence with each of the components continues in the survivor. So that the petitioner in this case is as a result of the merger, in contemplation of law of the corporation which suffered the loss. In this case the taxable office --
William J. Brennan, Jr.: Well, is it -- is it -- the statutory merger as to the constituent corporations that are swallowed up by the survivor continue in any sense?
Owen T. Armstrong Jr.: They do continue without substantive facts according to the usual exposition of the doctrine.
William J. Brennan, Jr.: Then, you can't sue them anymore, can you?
Owen T. Armstrong Jr.: No, but all their corporate -- yes, we can sue them. The --
William J. Brennan, Jr.: Is that under the laws of Missouri and --
Owen T. Armstrong Jr.: Under the laws of Missouri and Illinois. The doctrine is such that -- the only thing that doesn't continue as a matter of fact is the nominal existence. They thought the component corporations don't continue in the -- in the form of a -- of a separate corporation.
William J. Brennan, Jr.: Well, are you telling us that despite this merger then that these three corporations would suffer the losses may still be sued and be sued -- pursued and be sued where they were organized for instance?
Owen T. Armstrong Jr.: The statute provides that the -- that any -- any obligations of the component corporations after the merger may be sued upon by any person who has a right to sue them.
William J. Brennan, Jr.: Yes, but -- yes, but whom do you sue, the surviving corporation or the original corporation?
Owen T. Armstrong Jr.: You may name -- you may name the surviving corporation.
William J. Brennan, Jr.: May you sue the constituent corporations?
Owen T. Armstrong Jr.: As such?
William J. Brennan, Jr.: Yes.
Owen T. Armstrong Jr.: I don't think so. I don't think you can sue them as such, Your Honor. But the -- the concept of mergers that all the rights and all the -- all the obligations carry over and that that being the -- that -- that is incidentally is the -- the basis of the theory of the decision of this Court in Metropolitan Edison Company which did not involve a carry-over but which involved a tax benefit, which prior to the merger adhered to the component corporation. And the expression used by this Court was that the concept of the merger is such that the corporate identity of each component is drowned in the personality of the survivor or absorbed. It's -- to be sure it's a metaphor, it's a tenuous concept but it nevertheless is a well-recognized concept. And so that, we feel that that in itself is the answer to the first class that's over the Government's objection. The objection, you do not have the taxpayer who suffered the loss. Now, to be sure, the Government does press its second facet and the reason it does express it is because it feels that the second facet enables it to distinguish Newmarket, for example, which did not involve the problem of -- of the operation of -- of different assets by the surviving corporation from those who are operated by the component. Now, there was only one operating corporation in that case. But now, we feel that the Government's continuity argument is also -- can be -- can also be answered if we consider it carefully. The -- the argument in the brief was really made with three different levels. The Government begins by pointing to the committee report, the 1939 Committee Report, which was issued in connection with this enactment of this legislation and it picks up a quotation to the effect that this statute, the Section 122, permits a business to average its income over a period of years for tax purposes. And the Government suggests that the intention was to limit the right to the carry-over to that situation. The -- but it is submitted that that is of course the most irritable case, the ordinary case uncomplicated by any form of statutory reorganization for the merger or otherwise. And to be sure, if John Jones operates a business and suffers losses in the year one, the statute permits him to carry over those losses and offset them against profits earned in year two. But certainly, that is not the limit of the -- that was conferred by the statute. We may consider the next case. The case where (a) one operator, a corporation or otherwise has two separate businesses in the sense of two different accounting unit, different operation, perhaps a shoe store and -- and some other kind of a store. Now, it -- it may be asked in such a case which is the next most advanced case. Can he offset the losses of one of these accounting units against the profits of another? Can he carry forward the losses and allow such as against the profits for the other in the subsequent hearing? And the Government, in its brief, is compelled to answer that it -- that it make. Well, the Government indeed has argued that that too is improper. But even the Tax Court as without any deviation rejected the notion. If there is anything in the statute which associates the right to the carry-over with their particular business operation. The statute is termed in -- phrased in terms of the taxpayer. So that really, the -- the only issue here is whether we are correct in our proposition that the petitioner is the taxpayer with respect to the losses of each of the components. Now then, if I may continue the same analysis then I'll bring you on something that was developed earlier. Put the case of a -- of a reorganization, a merger in which as one of the justices suggested, the -- the surviving corporation is the loss corporation, the corporation which prior to the merger has the losses. Counsel for the Government was compelled to admit that there is no question but what under the very words of the statute, the carry-over would be allowed in such a case because the surviving corporation is -- he has to admit the taxpayer apart from the fact that it may be in such a case that the process of the subsequent juror against which this surviving corporation is going to accept the earlier losses, are not derived from assets which were formally operated by that loss corporation but were derived from other assets that were formally operated by the component corporations. It's just a converse of our case. As Justice Harlan indicated, it would seem to be a ridiculous artificiality to think that Congress would contemplate that result and at the same time contemplate the -- the opposite result in the -- in the case at bar.
Speaker: I didn't say ridiculous.
Owen T. Armstrong Jr.: No, sir. I didn't mean to quote you, paraphrasing it and practically carried away to a point. Now, that is -- that is one way in which the Government has tried to develop as argument of -- of the second facet of its case. The other level at which it has argued this facet is the level of the decided cases. Here, it has pointed to the case of New Colonial Ice Company and picked up the phrase "continuity of business" that was used in that -- by the Court in that case. That case if you will recall was a case, is the case -- not a merger but of a reorganization which a -- in which a new corporation was formed. And the Court -- and the Supreme Court in that case made it very clear that the reason why the carry over was not allowed was because there was a new corporation formed, and because it was not a statutory merger. The language used was, "This transfer was not by operation of law but by contract, therefore, you do not have the same taxpayer the second." And thus, clearly distinguishing our case. Now, that phrase "continuity of business" was taken out of context. The Government argues that since the phrase "continuity of business" was used there, do not necessarily mean something that is not present here, but it's not true. It's submitted that there's continuity of business here in the same sense in which there was continuity of business in that case. The sense in which the term was used there was this. The business operations formerly conducted by the loss corporation continued to be conducted by the new corporation. Continuity in that sense. Now, in the same sense, there is continuity here because the surviving corporation continues to operate the business assets formerly operated by the three loss corporations. The fact that it also operates additional assets formerly operated by other components does detract from the argument that there is continuity of the operation of the business which would result. And in the same way, the Government picks up a phrase in the Stanton Brewery case in its brief, the phrase "continuity of enterprise," and suggests again that it means identity of enterprise, identity of scope of the business before and after of the business which produced losses. And that against those profits the losses are upsetting. Again, that is demonstrative false analysis. And then turning to the final level of the Government's argument and this is something that I really want to mention because it again has been brought out by counsel for the Government here. Well, the concept of tax avoidance is introduced and it's quite extraneous. It's evident from the record that there is no question of tax avoidance here. Counsel suggests that if this result is permitted to obtain, there is a tax avoidance problem which this Court must take responsibility for. Of course he himself admits that it is -- even if he sees it, it's narrow in scope because the 1954 legislation allows the carry-over in this very situation, so it would apply only two years, affected by the 1939 Code. But over and above that, Congress in the 1939 Code in Section 129, addressed itself for the very problem of tax avoidance which might be inherent in this situation when it provided that when an outsider steps in and acquires a lost corporation, when new interest come into the picture and acquire a loss corporation for a purpose of tax avoidance, then a loss carry-over is not permitted. And there -- there of course -- of course there's no such case here as we have no change in ownership, no question of outside interest acquiring a -- a business for the purpose of utilizing that loss. So that again, the Government's argument at the level of the appeal to -- to some concept of justice and tax avoidance is without merit.
Felix Frankfurter: Does that argument mean that if a primary corporation, privately -- privately held shares becomes a public corporation that your argument impose?
Owen T. Armstrong Jr.: I believe that is correct, Your Honor, under the application Section 129. If there is a substantial change in stock ownership of a corporation and if the acquisition of the corporation by the new interest is for a purpose of tax avoidance because of the two conditions, then the loss carry-over is not permitted.
Felix Frankfurter: Generally speaking?
Owen T. Armstrong Jr.: That's correct. And in that same --
Felix Frankfurter: Therefore, this family is -- is a family with a large (Inaudible) nephews and nieces have a loss and if (Inaudible) that's admitted or was not.
Owen T. Armstrong Jr.: Under the language of Section 129, I don't think --
Felix Frankfurter: Well, under your argument. That under your argument, it wouldn't have had to do it.
Owen T. Armstrong Jr.: No, Your Honor. Now, there may be some other things.One thing was mentioned, another conclusion. It was pointed out that Learned Hand had dissented in the Stanton Brewery case. The fact is that his dissent was not based upon a rejection of the same taxpayer argument which was advanced by counsel for the taxpayer in that case. His dissent was based upon consideration of other statutes which affected the problem of excess profits tax credit carry-over and which do not affect the problem of net operating loss carry-over.
Stanley Reed: Does carry-back carry over a bargain like in corporations or as an individual (Inaudible)
Owen T. Armstrong Jr.: It applies to individuals of those corporations, Your Honor.
Stanley Reed: Do they have any problems for the -- the individual may organize a corporation and take over his business?
Owen T. Armstrong Jr.: The right to the carry-over attaches to the -- to the taxpayer who has sustained the loss in the first instance. If an individual for a given taxable year has sustained a loss, that loss is a -- is the carry-over to that individual. Now, there is no way -- no theory of law that by which -- by which we can identify a corporation organized by him with that individual.
Stanley Reed: Even though it took over the same grocery store to be --
Owen T. Armstrong Jr.: That's correct Your Honor. We do not pretend that the term "taxpayer" encompasses that type of a change. However, because of the doctrine of statutory merger, we -- we contend that the -- that document itself takes us over the bridge, so to speak, of this problem with the same taxpayer. A word from the Government says that -- that it's resolving a question by means of resort to state law, but we do not see it that way. As counsel for petitioner pointed out in the first part -- part of our argument, it is not that case at all because the Internal Revenue Code itself, the whole Code necessarily incorporates the -- the private corporation law of the several states whenever it speaks for the corporation. And it incorporates -- the corporation law for that purpose, it must be incorporated for the purpose of the -- of statutory merger which is a familiar concept and which is used in the code without definition. The code in the reorganization section includes the statutory merger as one of the kinds of reorganization, a tax-free reorganization without bothering to define the term. So that, it is a familiar concept and the notion that we are permitting state law to govern tax consideration is not found. It was suggested by one of the justices that the result here may be improper and that individuals could not avail themselves of these tax benefits in a comparable situation. Of course, there is no law of merger of individual which distinguishes that case. There is a law of statutory merger of corporation which readvanced and support the notion that the taxpayer here, the petitioner is a taxpayer who suffered the loss.
Earl Warren: Well, thank you.