Opinion ID: 1578326
Heading Depth: 1
Heading Rank: 2

Heading: The Internal Revenue Code Section 334(b)(2) Issue.

Text: As indicated in the above factual recital, plaintiff corporation sought to acquire and merge with Barnum under circumstances that would permit it to succeed to the latter's net operating loss carry-overs. See I.R.C. § 381. Internal Revenue Code section 381(a)(1), however, specifically denies carry-over of a liquidated subsidiary's tax attributes to the acquiring corporation when the latter has acquired the subsidiary in a manner bringing it within the provisions of Internal Revenue Code section 334(b)(2). The fighting in this trial focused on the latter provision of the federal law. Internal Revenue Code section 334(b)(2) represented [2] the statutory codification of the so-called Kimbell-Diamond rule, see 14 T.C. 74, aff'd, 187 F.2d 718 (5th Cir. 1950), cert. denied, 342 U.S. 827, 72 S.Ct. 50, 96 L.Ed. 626 (1951). By following its provisions, the continuing corporation is entitled to a stepped up basis in the assets received, equal to its adjusted basis in the capital stock of the subsidiary corporation. In keeping with the theory that a § 334(b)(2) transaction is in substance a purchase of the assets, the acquiring corporation does not inherit the liquidating corporation's earnings and profits or other tax attributes, as it would in a `normal' liquidation of a subsidiary by its parent. B. Bittker and J. Eustice, Federal Income Taxation of Corporations and Shareholders § 11.44 (4th ed. 1979). Both parties concede that Martinson was required to fall without, or flunk the section 334(b)(2) requirements in order to utilize Barnum's NOLS. This requires us to consider the provisions of that section. As adopted in the 1954 revenue act, section 334(b)(2) provided: EXCEPTION.If property is received by a corporation in a distribution in complete liquidation of another corporation (within the meaning of section 332(b)), and if (A) the distribution is pursuant to a plan of liquidation adopted (i) on or after June 22, 1954, and (ii) not more than 2 years after the date of the transaction described in subparagraph (B) (or, in the case of a series of transactions, the date of the last such transaction); and (B) stock of the distributing corporation possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote, and at least 80 percent of the total number of shares of all other classes of stock (except nonvoting stock which is limited and preferred as to dividends), was acquired by the distributee by purchase (as defined in paragraph (3)) during a period of not more than 12 months, then the basis of the property in the hands of the distributee shall be the adjusted basis of the stock with respect to which the distribution was made. Internal Revenue Code of 1954, ch. 736, § 334(b)(2), 68A Stat. 105 (1954) (emphasis added). In 1966 Congress sought to permit an acquiring corporation to obtain 80 percent of the stock in a target corporation by purchasing a controlling interest in a third corporation owning stock in the target corporation, while avoiding the effect of the Internal Revenue Code section 318 attribution rules. In amending section 334(b)(2) to effect this result, the underlined language in the above-quoted portion of the statute was deleted from subparagraph (B) and the following was substituted: [D]uring a 12-month period beginning with the earlier of (i) the date of the first acquisition by purchase of such stock, or (ii) if any such stock was acquired in an acquisition which is a purchase within the meaning of the second sentence of paragraph (3), the date on which the distributee is first considered under section 318(a) as owning stock owned by the corporation from which such acquisition was made, Foreign Investors Tax Act, Pub.L.No. 89-809, § 202(b), 80 Stat. 1539, 1576 (1966) (emphasis added). It seems apparent that only subparagraph B(ii) involves acquisition of shares in a corporation owning stock in the target corporation. Subsection B(i), on the other hand, refers to the direct purchase of stock in the target corporation, and it is this provision that riveted the attention of these litigants. Plaintiff contended that such stock referred to the stock comprising the 80 percent control block required by section 334(b)(2)(B); thus Martinson's one-shot purchase of 80 percent of Barnum's stock put it squarely within section 334(b)(2), and consequently, Barnum's NOLS were lost. Defendant contended such stock referred to any stock purchased in the target corporation. In this case, therefore, implementation of the Barnum acquisition plan would fall outside the parameters of section 334(b)(2) because Martinson acquired its initial Barnum shares in September 1975, some thirteen months before its final purchase in October 1976. Moreover, each party provided competent tax experts to support its statutory interpretation. Plaintiff called as witnesses two tax specialists, one of whom had a prior involvement in plaintiff's tax problems and had advised against attempting to claim the NOLS on Martinson's tax returns. A silent witness for defendant was Williams, who died in June 1976. According to plaintiff's witnesses Williams was an outstanding tax attorney who wrote the tax aspects of the acquisition plan. That plan, presented to Martinson's directors on March 4, 1976, recited the purchase of the Barnum shares in September 1975, and proposed the further acquisition of the 80 percent owned by the Iowa investors by a 40 percent purchase upon approval of the plan and the remaining one-half . . . in October or November, 1976. Clearly, Williams believed the 1975 Barnum stock purchase launched the subsection 334(b)(2)(B)(i) first acquisition by purchase, and the final purchase thirteen months later would avoid NOL forfeiture. Defendant produced another expert tax attorney who presented persuasive testimony for defendant's interpretation, and of course this position was supported by defendant. One of plaintiff's certified public accountants testified he saw nothing wrong with the manner in which the stock was acquired. Neither litigant could produce any case authority on the point in issue, nor has our research disclosed a helpful decision. Plaintiff claims support in Treasury Regulation 1.334-1(c) and Prentice-Hall 1968 Tax Handbook § 3316. Neither source, however, directly addresses the issue litigated in this case, and neither ties that issue to the 1966 change in the statutory language. Both concentrate on the final date of a series of stock purchases totaling at least 80 percent of the subsidiary, to determine the start of the two-year period during which the acquiring corporation is required by the statute to liquidate the acquired corporation. Neither source addresses the new language that, for the first time, appeared to fix a beginning date for the twelve-month period within which the required 80 percent of the subsidiary's stock must be acquired. After overruling defendant's motions for directed verdict, trial court, over the objections of both parties, left the matter to the jury's determination in the following instruction: Where one corporation acquires another by purchase, various sections of the Internal Revenue Code permit the acquiring corporation (in this case Plaintiff Martinson) to take advantage of the acquired corporation's (Barnum) net operating loss carry-forward if certain conditions are met. One of these conditions is that 80 percent or more of the acquired corporation's stock must be acquired in a certain period. It is for you to determine from the evidence in this case whether or not the 80 percent of stock in Barnum was properly acquired. Both parties assert this was error, and each contends trial court should have instructed the jury the respective party's interpretation was the correct one. In affirming, the court of appeals reasoned the defendant's verdict necessarily implied the jury found the acquisition of Barnum stock was structured so as not to come within the provisions of section 334(b)(2); thus its finding there was no malpractice in the Barnum acquisition. Because the court of appeals also found defendant's interpretation of that section to be correct, it held that allowing the jury to interpret the statute did not constitute reversible error. The first premise for the court of appeals decision does not allow for the possibility that the jury may have found for defendant on other grounds, including his defense that he was employed only to carry out an acquisition plan devised by Williams. It is not necessary to reach the second premise, in our view, because defendant's fallback position is well taken: The error, if any, was harmless because trial court should have directed a verdict for him. There was not substantial evidence in the record to justify submission of the case to the jury where, as here, the evidence was so strong as to show as a matter of law that the interpretation of section 334(b)(2) was a question on which reasonable doubt could be entertained by well-informed lawyers. We believe the authorities cited in division I fully support this holding.