Opinion ID: 374911
Heading Depth: 2
Heading Rank: 1

Heading: Continuity-of-interest requirements for differing tax consequences

Text: 23 To reiterate the context of the issue before us: the Olivier-USI plan met the requirements of a statutorily-recognized C reorganization pursuant to section 368(a)(1)(C), and the favorable reorganization tax-consequences were thus available. In addition, the Olivier sale of USI stock during Olivier's plan of liquidation literally met the requirements of section 337; therefore, no taxable corporate gain is recognized if that section applies. Further, no reorganization or liquidation provision of the I.R.C. conflicts with the application of section 337 to the sale during Olivier's liquidation. The issue we are thus called upon to decide is: Are the tax-consequence-free benefits of section 337 available with respect to a sale made by a corporation to third persons during its liquidation, when that liquidation is a step in a C reorganization? 11 24 The government attacks the application of section 337 to this sale (and insists that the corporate gain should be recognized) on the theory that a liquidation (cessation of business; termination of shareholders' interest) is conceptually incompatible with a reorganization (continuance of business; continuity of shareholders' interest). The government's argument is primarily based, as was the decision in FEC Liquidating Corporation, upon expressions and holdings in several judicial decisions, none directly involving the issue before us. 12 These decisions have denied liquidation treatment to the distribution of assets to shareholders who liquidate their corporations shortly before reincorporating the operating assets in a separate corporation in which they own a substantial interest, usually in a liquidation made as an integral part of a corporate reorganization with reorganization tax advantages likewise applicable. In these instances, a continuity of interest by the former shareholders in the new corporate enterprise has been held to defeat concurrent application of taxpayer-favoring liquidating provisions. 25 In all of these instances, however, the former shareholders (unlike those before us) retained a substantial continuing interest in the reorganized corporate enterprise, at least fifty percent or more. The essential reason for denying liquidation benefits either section 337 non-recognition treatment of a sale made during the liquidation or capital gains treatment to a liquidating distribution was that substantially the same business was being conducted by the new corporate entity owned by substantially the same shareholders. The liquidation was only a device in connection with a mere shifting of charters, Helvering v. Elkhorn Coal Co., 95 F.2d 732, 734 (4th Cir. 1938), by which to avoid tax consequences on corporate sales or distributions that were fully taxable if made by the original corporation before its transmutation into the new corporate entity carrying on substantially the same business with substantially the same shareholders. 26 In the present case, however, the taxpayers' former 100% stock ownership of Olivier was transformed by the C reorganization into a 0.6% interest in the outstanding shares of USI, and Olivier itself was completely liquidated as a corporate entity. The sale of assets to third persons during the plan of liquidation was primarily for the purpose of satisfying Olivier's corporate liabilities prior to its complete liquidation; it qualifies for nonrecognition treatment under the literal terms of section 337 in accordance with the apparent Congressional intent. Unlike the decisions relied upon by the government, the liquidation in this case was not utilized in connection with a mere shifting of corporate charters in order to avoid taxes otherwise due; instead, Olivier was completely liquidated in connection with its C reorganization recognized by the I.R.C. (see note 11, supra ). Olivier is entitled to section 337 non-recognition treatment as well as to application of the reorganization provisions, because both apply to it under the express terms of the I.R.C. provisions enacted by Congress and both may apply without detriment to any tax policy or provision enunciated by the I.R.C. as a whole. 27 The government concedes that there was sufficient continuity of interest to justify reorganization treatment. See Bittker & Eustice, PP 14.11, 14.51. The government contends, however, that this continuity of interest prevents our holding that Olivier's liquidation was complete. In addition to relying upon FEC Liquidating Corporation, which we (like the trial court) think incorrectly applied the decisions discussed above, the government (as did the FEC court) relies upon dicta in Pridemark, Inc. v. Commissioner, 345 F.2d 35 (4th Cir. 1965). There, capital gains liquidation treatment was allowed where there was a complete transfer of assets and cessation of business by the liquidated corporation. However, the court also added that, for liquidation benefits to be applicable, (t)he corporation must have ceased to be a going corporate concern, or if the enterprise is continued in corporate form, the shareholder must have disassociated himself from it. Id. at 345 F.2d 41 (italics ours). 28 The jurisprudence does not support this dicta that, in order for a dissolved corporation and its shareholders to be accorded liquidation treatment, there must be a complete disassociation of its former stockholders from the new corporate entity. The Second and Ninth Circuits have held that where there is a bona fide liquidation for a valid business purpose, in connection with a corporate reorganization that results in a significant shift of control and lessening of the former shareholder's interest in the new corporate enterprise, the mere continuity of interest of the former shareholder in the new corporate enterprise does not preclude the application of the liquidation benefits available to the liquidated corporation and its shareholders under sections 331 and 337, in accordance with their statutory language and the apparent Congressional intent. Breech v. United States, 439 F.2d 409 (9th Cir. 1971) (20% continuing interest of former shareholder); Commissioner v. Berghash, 361 F.2d 257 (2d Cir. 1966) (50% continuing interest of former shareholders). 13 29