Opinion ID: 415638
Heading Depth: 1
Heading Rank: 4

Heading: the f reorganization theory

Text: 38 The Code defines an F reorganization as a mere change in identity, form, or place of organization, however effected. I.R.C. Sec. 368(a)(1)(F). This provision of the Code is not further amplified by the regulations and until recently received little judicial or administrative attention. See B. Bittker & J. Eustice, Federal Income Taxation of Corporations & Shareholders p 14.18 (1979). Apparently F reorganization treatment originally was intended to apply only to a narrow category of formalistic changes in the structure of a single corporation. See Metzer, An Effective Use of Plain English--The Evolution and Impact of Section 368(a)(1)(F), 32 Tax Law. 703, 704-08 (1979). This form of corporate restructuring has been expanded greatly through the case law, however; today the scope of F reorganizations includes mergers of a subsidiary into its parent, see Movielab, Inc. v. United States, 494 F.2d 693 (Ct.Cl.1974), fusions of multiple affiliated operating companies, see Estate of Stauffer v. Commissioner, 403 F.2d 611 (9th Cir.1968), and consolidations of multiple subsidiaries into a single subsidiary, see Home Construction Corp. v. United States, 439 F.2d 1165 (5th Cir.1971). 9 39 In Davant v. Commissioner, 366 F.2d 874 (5th Cir.1966), cert. denied, 386 U.S. 1022, 87 S.Ct. 1370, 18 L.Ed.2d 460 (1967), and Home Construction Corp. of America v. United States, 439 F.2d 1165 (5th Cir.1971), the Fifth Circuit established several criteria for F reorganization treatment. A combination of two or more corporations qualifies as a mere change in identity, form, or place of organization if there is an identity of shareholders and their proprietary interests, unimpaired continuity of the essential business enterprise and a new form which is the alter ego of the old. Home Construction, 439 F.2d at 1170. Furthermore, there must be a legitimate business purpose independent of and in addition to the tax consequences of the merger. Id. at 1172. 10 Thus a corporation may be born again by the grace of section 368(a)(1)(F), provided there are no distortions in the corporation's ownership, business, or purposes. 40 The controversy in this case focuses upon the requirement of an identity of shareholders and their proprietary interests. This continuity of interest doctrine developed as a judicial embellishment of the Codal reorganization provisions 11 and is now codified in the applicable regulations, which provide that [t]he term [reorganization] does not embrace the mere purchase by one corporation of the properties of another corporation, for it imports a continuity of interest on the part of the transferor or its shareholders in the properties transferred. Treas.Reg. Sec. 1.368-2(a). Thus, in order for a corporate combination to warrant tax-free reorganization treatment, the former owners of the acquired corporation must maintain a continuing proprietary interest in the acquiring corporation. This circuit has emphasized the importance of continuity of shareholder interest in the context of F reorganizations, noting that a substantial shift in the proprietary interest in a corporation accompanying a reorganization can hardly be characterized as a mere change in identity or form. Davant, 366 F.2d at 883 (citing Helvering v. Southwest Consolidated Corp., 315 U.S. 194, 62 S.Ct. 546, 86 L.Ed. 789 (1942)). 41 The continuity of interest issue here is basically one of timing: at what stage in these transactions should the shareholders' proprietary interests be measured? The district court, adopting Security's position, viewed OIC's initial purchases of the Southern and Standard stock as transactions separate and distinct from the later liquidations of the two corporations and their mergers into Security. The district court accordingly limited its evaluation of continuity of shareholder interest to the proprietary interests in Southern, Standard, and Security as they stood following the time of OIC's original stock purchases. At that point, Southern, Standard, and Security exhibited complete identity of shareholder interests; OIC, the Ourso family holding company, owned all the stock in all three insurance companies. Viewing the transactions through this narrow time window, the district court held that the continuity of interest requirement for F reorganizations was satisfied. 42 The government advocates the use of a wider time window for measuring the continuity of proprietary interests in this case. The government asserts that the stock purchases, asset transfers, reinsurance agreements, and liquidations were all merely intermediate steps in Security's plans to acquire the assets of Southern and Standard for cash. Concomitantly, the government urges that, in testing these corporate combinations for continuity of shareholder interest, the proprietary interests in Southern and Standard as they existed prior to OIC's purchases of stock must be compared to the proprietary interests in Security after Southern and Standard were dissolved. Of course, Southern's and Standard's original shareholders had no post-acquisition proprietary interest in Security; all the original shareholders of Southern and Standard were cashed out. Accordingly, the government claims, the continuity of interest requirement was not satisfied, and Security is not entitled to favorable F reorganization treatment. 43 The linchpin of the government's argument is the application of the step transaction doctrine. Unquestionably, if these transactions are amalgamated and viewed in their entirety, the continuity of interest requirement is not satisfied. In order to evaluate properly the government's argument, we therefore turn to an exposition of the step transaction doctrine.

44 The step transaction doctrine is a corollary of the general tax principle that the incidence of taxation depends upon the substance of a transaction rather than its form. See Kuper v. Commissioner, 533 F.2d 152, 155 (5th Cir.1976) (citing cases). Under the step transaction doctrine, the tax consequences of an interrelated series of transactions are not to be determined by viewing each of them in isolation but by considering them together as component parts of an overall plan. Crenshaw v. United States, 450 F.2d 472, 475 (5th Cir.1971). When considered individually, each step in the series may well escape taxation. The individual tax significance of each step is irrelevant, however, if the steps when viewed as a whole amount to a single taxable transaction. Id. at 476. [Taxpayers] cannot compel a court to characterize the transaction solely upon the basis of a concentration on one facet of it when the totality of circumstances determines its tax status. Id. at 477. 45 The types of step transactions are as varied as the choreographer's art: there are two steps, waltzes, fox trots, and even Virginia reels. As a consequence, the courts' applications of the step transaction doctrine have been enigmatic. As the Seventh Circuit observed: 46 The commentators have attempted to synthesize from judicial decisions several tests to determine whether the step transaction doctrine is applicable to a particular set of circumstances in order to combine a series of steps into one transaction for tax purposes. Unfortunately, these tests are notably abstruse--even for such an abstruse field as tax law. 47 Redding v. Commissioner, 630 F.2d 1169, 1175 (7th Cir.1980), cert. denied, 450 U.S. 913, 101 S.Ct. 1353, 67 L.Ed.2d 338 (1981). Although no test seems to be universally accepted, it is possible to articulate several standards used by the courts in determining when and how to apply the step transaction doctrine. See B. Bittker & J. Eustice, supra, p 14.51 (suggesting that different tests are applicable in different contexts). 48 The test most often invoked in connection with the application of the step transaction doctrine is the end result test. Under this test, purportedly separate transactions will be amalgamated into a single transaction when it appears that they were really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate result. King Enterprises, Inc. v. United States, 418 F.2d 511, 516 (Ct.Cl.1969). As the Fifth Circuit has noted, when cases involve a series of transactions designed and executed as parts of a unitary plan to achieve an intended result, the plans will be viewed as a whole regardless of whether the effect of doing so is imposition of or relief from taxation. Kanawha Gas & Utilities Co. v. Commissioner, 214 F.2d 685, 691 (5th Cir.1954) (emphasis added). See also Kuper, 533 F.2d at 155-56; Crenshaw, 450 F.2d at 476; Redwing Carriers, Inc. v. Tomlinson, 399 F.2d 652, 658 (5th Cir.1968). 49 A second test for determining whether the step transaction doctrine applies is labelled the interdependence test. This test focuses on whether the steps were so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series. Paul & Zimet, Step Transactions, in Selected Studies in Federal Taxation 200, 254 (2d Ser.1938), quoted in King Enterprises, 418 F.2d at 516. See also Redding, 630 F.2d at 1177; American Bantam Car Co. v. Commissioner, 11 T.C. 397 (1948), aff'd per curiam, 177 F.2d 513 (3d Cir.1949), cert. denied, 339 U.S. 920, 70 S.Ct. 622, 94 L.Ed. 1344 (1950); 3 J. Mertens, The Law of Federal Income Taxation Sec. 20.161 (Doheny ed. 1981). When it is unlikely that any one step would have been undertaken except in contemplation of the other integrating acts, Kuper, 533 F.2d at 156, step transaction treatment may be deemed appropriate. 50 The third and most restrictive test permitting invocation of the step transaction doctrine is the binding commitment test. The Supreme Court enunciated this standard in Commissioner v. Gordon, 391 U.S. 83, 88 S.Ct. 1517, 20 L.Ed.2d 448 (1968), when it refused to aggregate stock distributions occurring several years apart for tax purposes. The Court commented that if one transaction is to be characterized as a 'first step' there must be a binding commitment to take the later steps. Id. at 96, 88 S.Ct. at 1524. Thus the binding commitment test requires telescoping several steps into one transaction only if a binding commitment existed as to the second step at the time the first step was taken. Subsequent decisions, however, have tended to confine Gordon to its facts. The Seventh Circuit, for example, has concluded that lack of a binding commitment should be determinative only in cases involving multi-year transactions; in other situations, the presence or absence of a binding commitment is simply one factor to be considered. See McDonald's Restaurants v. Commissioner, 688 F.2d 520, 525 (7th Cir.1982); Redding, 630 F.2d at 1178. Similarly, the Court of Claims has read Gordon 's binding commitment requirement as limited to an interpretation of particular statutory language in section 355 concerning divisive reorganizations. See King Enterprises, 418 F.2d at 517-18. The King court reasoned: 51 The opinion in Gordon contains not the slightest indication that the Supreme Court intended the binding commitment requirement as the touchstone of the step transaction doctrine in tax law .... Clearly, the step transaction doctrine would be a dead letter if restricted to situations where the parties were bound to take certain steps. 52 Id. at 518 (emphasis in original). See also B. Bittker & J. Eustice, supra, p 14.51 (binding commitment standard may be reserved for situations where taxpayer rather than government invokes step transaction doctrine); Levin & Bowen, Taxable and Tax-Free Two-Step Acquisitions and Minority Squeezeouts, 33 Tax L.Rev. 425, 428 n.6 (1978) (Gordon limited to divestiture of control requirement in D reorganization). 53 We believe that both the end result test and the interdependence test are helpful in analyzing multiphase transactions in terms of the step transaction doctrine. Each is faithful to the central purpose of the step transaction doctrine: ensuring that the tax consequences of a particular transaction turn on substance rather than form. In prior cases involving step transaction treatment, the Fifth Circuit has employed both tests on various occasions. See Kuper, 533 F.2d at 155-56 (end result and interdependence); Crenshaw, 450 F.2d at 475-78 (end result and interdependence); Kanawha Gas & Utilities Co., 214 F.2d 685, 691 (end result). Furthermore, we conclude that the Gordon binding commitment test should be strictly limited to the facts of the case that gave it life. General application of the binding commitment standard would effectively permit taxpayers to evade the step transaction doctrine merely by abstaining from formal commitments. Such a result, which would emasculate the doctrine itself, is in no way mandated by the Gordon opinion. See King Enterprises, 418 F.2d at 518. We therefore turn to an examination of the facts of this case in light of the end result and interdependence tests.
54 The government argues that the step transaction doctrine should be applied in this case to defeat F reorganization treatment of the acquisitions of Southern and Standard and the accompanying tax-free carryovers of their policyholders surplus accounts. In particular, the government asserts that the transactions involved in this case fail to satisfy the continuity of interest requirement of F reorganizations when scrutinized in terms of the step transaction doctrine. We have determined that the end result test and the interdependence test are the appropriate standards to be used in deciding when to apply step transaction analysis. Accordingly, we must now apply the end result and interdependence tests to ascertain whether the step transaction doctrine governs the outcome of this case. We conclude that under either test the transactions involved here should be stepped together, and when viewed in such a way, the acquisitions of Southern and Standard fail to qualify as F reorganizations. 55 Under the end result standard of step transaction analysis, purportedly separate transactions are to be amalgamated when the successive steps were designed and executed as part of a plan to achieve an intended result. Kanawha Gas & Utilities Co., 214 F.2d at 691. In this case we are faced with a dizzying array of legal maneuvers: OIC's purchases of Southern's and Standard's stock, the reinsurance agreements between Southern, Standard, and Security, the transfers of Southern's and Security's assets through OIC to Security, and, finally, the liquidations of Southern and Security under state law. Yet all these machinations cannot disguise the fact that the intended result of each series of transactions was the acquisition of Southern's and Standard's assets by Security. Security and OIC left a clear and well-documented paper trail to this effect. 12 Security's game plans for acquiring Southern and Standard were identical to the strategy it had pursued for over twenty years: liquidate the rival company and gobble up the assets. Such a plan of acquisition amounts to nothing more than a taxable cash purchase by Security of Southern's and Standard's assets. A given result at the end of a straight path is not made a different result because reached by following a devious path. Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613, 58 S.Ct. 393, 395, 82 L.Ed. 474 (1938). Thus these transactions must be viewed in their entireties under the end result test of the step transaction doctrine. 56 The interdependence test for applying step transaction analysis asks whether the individual steps in a series had independent significance or whether they had meaning only as part of the larger transaction. This test concentrates on the relationship between the steps, rather than on their end result. McDonald's Restaurants, 688 F.2d at 524. Thus, under this test we examine this tandem of transactional totalities to determine whether each step had a reasoned economic justification standing alone. An analysis of the transactions at issue in this case indicates that each step was dependent for its success upon each of the others; in isolation, the steps were meaningless. OIC was a mere shell, formed only to facilitate the purchases of Southern and Standard. The purchases of Southern and Standard would have been impossible without elaborate financing arrangements between OIC and the Bank; these financing agreements were dependent in part on the contingent payment agreements and reinsurance agreements between the various parties, because the collateral agreements guaranteed that OIC would have a cash flow sufficient to discharge its debt to the Bank. The transfers of assets from Southern and Standard to Security were necessary to effectuate the reinsurance agreements with Security. These complicated interrelationships demonstrate that each step in the transactions led inexorably to the next. Such a symbiotic relationship clearly satisfies the interdependence test for application of the step transaction doctrine. 57 Analysis of the Southern and Standard acquisitions under the end result test indicates that each element of the transactions was designed and executed as part of Security's plan to acquire the assets of Southern and Standard. Application of the interdependence test to these transactions reveals individual components so interrelated that no single step would likely have been taken had the others not followed. Thus, under either of the two prevailing standards used to determine whether step transaction analysis should be applied, the events that transpired in connection with the acquisitions of Southern and Standard should be amalgamated and viewed as a single transaction.
58 As discussed above, both the end result test and the interdependence test require that we view the Southern and Standard acquisitions through the telescopic lens of the step transaction doctrine. Specifically, we must incorporate this composite perspective of the acquisitions into our evaluation of the continuity of interest requirement of F reorganizations. When the acquisitions are examined in the step transaction context, they clearly fail to satisfy the requirement of continuity of proprietary interest. The original shareholders of Southern and Standard were eliminated from the continuity of interest calculus by OIC's purchases of the Southern and Standard shares. No former shareholder of Southern or Standard retained a proprietary interest in Security following these transactions. Such complete cash outs of the Southern and Standard shareholders cannot qualify as F reorganizations, because a substantial shift in the proprietary interest in a corporation accompanying a reorganization can hardly be characterized as a mere change in identity or form. Davant, 366 F.2d at 883. 13 59 Thus, in each of the acquisitions challenged here, the original stock purchase, the transfer of assets, and the ultimate liquidation must be aggregated for tax purposes under the step transaction doctrine. So aggregated, these transactions do not satisfy the requirements of an F reorganization because the necessary continuity of proprietary interest was lacking. See Levin & Bowen, supra, at 475-77 (concluding that a similar multi-step transaction is not an F reorganization due to lack of continuity of interest). The district court held that F reorganizations had occurred without considering the application of the step transaction doctrine to these facts. In so doing, the district court erred in failing to apply the correct legal standard. 14 Accordingly, we reverse the district court and hold that the acquisitions of Southern and Standard do not qualify as F reorganizations. Security's claim of entitlement to tax-free carryovers of Southern's and Standard's policyholders surplus accounts by virtue of F reorganization treatment must therefore fail.