Court Opinion

ID: 4483895
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:22.221445+00
Date Added: 2024-06-11T14:53:45.213897
License: Public Domain

Sterrett, J., dissenting: In my view, the majority misconceives the reality of the transaction in issue. The admitted goals to be accomplished by the transaction at issue were (1) at the instigation of the Indiana Public Service Commission, the divestiture of Shorewood by Water Co. and (2) the raising of additional capital for Shorewood. To disgorge itself of subchapter C control (80 percent) of Shorewood and at the same time raise funds for its former subsidiary, Water Co. adopted a rather simple plan. It agreed to buy additional shares (855,630) from Shorewood contingent on the offering of these shares, plus a portion (213,907 out of 481,291) of the shares it already owned in Shorewood, to the holders of warrants which it intended to distribute with respect to its stock, on the basis of two warrants plus $5 for each share of Shorewood. Thus Shorewood could anticipate receiving in excess of $4 million in additional capital, Water Co. would have distributed 80 percent plus 1 share of Shorewood’s outstanding stock, and received $1 million in fresh capital. A perfectly reasonable means of accomplishing the two disparate corporate goals, but simply not within either the literal or spiritual ambit of section 355. We must note at the outset that the Supreme Court in Commissioner v. Gordon, 391 U.S. 83, 91-94 (1968), has instructed us to construe section 355 narrowly: Section 355 provides that certain distributions of securities of corporations' controlled by the distributing corporation do not result in recognized gain or loss to the distributee shareholders. The requirements of the section are detailed and specific, and must be applied with precision * * * . Congress has abundant power to provide that a corporation wishing to spin off a subsidiary must, however bona fide its intentions, conform the details of a distribution to a particular set of rules. [Emphasis added.] In the instant case, the petitioners received property in the form of warrants with respect to their Water Co. stock that had independent value since the warrants entitled them to a bargain purchase of Shorewood stock. Normally, this would constitute a distribution of property taxable as a dividend either at the time of receipt or at the time of sale or exercise. Palmer v. Commissioner, 302 U.S. 63 (1937). Petitioners seek to avoid this result by applying the step or integrated transaction theory to couple the warrant distribution with the subsequent exchange of two warrants and $5 for 1 share of Shorewood stock. Petitioners’ argument can fairly be paraphrased in terms that they contend that, since the warrants were distributed with respect to the Water Co. stock and since the use of the warrants to obtain Shorewood stock was an integral part of the warrant distribution plan, Shorewood stock then must also have been distributed with respect to Water Co. stock. I cannot accept petitioners’ rationale. I believe that the stock warrant issuance herein must be given independent significance and cannot simply be ignored because accompanied by an apparent spinoff. Further, I believe that, even if the rights issuance does not totally contaminate the purported section 355 divisive reorganization, the transaction before us still fails to qualify under section 355 because it has not been shown that the requisite control was distributed. I must comment here that, while the majority attempts to limit the effects of its opinion by assuring us that it “goes no further than the facts of this case,” Redding v. Commissioner, 71 T.C. 597 (1979), the principles announced by the majority are not so limitable. They will apply equally to, and will affect the tax treatment of, all the shareholders of both Water Co. and Shorewood. It is irrelevant that petitioners sold none of their rights, exercised all of them, and received stock therefor (with the additional consideration of $5 cash per Shorewood share). Rather, our treatment of petitioners should depend on the substance of the transaction as a whole. The majority finds that the “issuance of the rights by Water Co. was merely a procedural device to give Water Co. shareholders the opportunity to be included or excluded from the Shorewood stock distribution by their own decision.” Redding v. Commissioner, supra at 612. But the rights issuance was much more than a mere “procedural device,” it was the method through which Water Co. intended to obtain the capital funding for Shorewood (and possibly itself) which was one of the primary purposes behind the whole transaction. Further, the very words quoted above indicate that the rights issuance was much more than a mere procedural device to all the shareholders of Water Co. at the time of the issuance. For these shareholders, the rights issuance was a turning point — they could choose to pay $5 per Shorewood share and keep what they already owned, or could almost certainly sell the rights at a profit and lose their ownership interest in Shorewood, thereby surrendering the opportunity of buying Shorewood stock at a bargain. The shareholders could sell the rights only because they were valuable property interests and because, as Water Co. had “expected” and planned for, they were traded over the counter. Indeed, Shorewood stated in the prospectus dated January 7, 1971, issued with respect to the warrant distribution, that it “expected” that such trading would occur. Water Co. and Shorewood arranged for a “subscription agent” to be available to Water Co.’s warrant holders (regardless of whether they were shareholders) to facilitate the sale and exchange of these rights. It is clear, therefore, that Water Co. anticipated that some, perhaps many, of its shareholders would for one reason or another choose not to exercise the rights issued to them and wanted to facilitate the transfer of these rights into the hands of persons who would exercise them. Thus, the use of transferable stock rights was one of the primary methods Water Co. used to attract new capital to the entire Shore wood/Water Co. corporate enterprise. When we think of an integrated transaction, we think of steps bound together, perhaps legally so, with no uncertainty from one step to the next. Here there was no absolute requirement that the shareholders exercise the warrants. Admittedly, the warrants were freely transferable and entitled the holder to a bargain purchase of Shorewood stock. Hence the probabilities were, from a practical point of view, that the warrants would be either exercised or sold. Nonetheless, to get Shorewood stock required an affirmative act on the part of each warrant holder which he was under no compulsion to take. Thus, I object to the majority’s conclusion that the rights issuance was of no independent significance. The transfer by Water Co. of Shorewood stock to Water Co. warrant holders was clearly conditioned on the payment of the $5 cash consideration per share. This was the transfer of property in consideration for the payment of money. In the Baan case on remand, Baan v. Commissioner, 51 T.C. 1032, 1037 (1969), affd. 450 F.2d 198 (9th Cir. 1971), affd. sub nom. Gordon v. Commissioner, 424 F.2d 378 (2d Cir. 1970), this Court found an almost identical transaction to be a “sale.” Given the majority’s restrictive view of the impact and import of the Supreme Court decision in Commissioner v. Gordon, supra at 83, this was not a holding requirement by that opinion and can only be interpreted as a shift in position by this Court.1  Even if there was a “distribution” of stock within the meaning of section 355, and a further consequence of the issuance of warrants, it was not solely of Shorewood stock with respect to Water Co. stock. See sec. 355(a)(1). It is clear that Water Co.’s plan did not call for the distribution of stock to shareholders— and that the “distribution” of stock that did occur was not in respect of any stock in Water Co. The prerequisite to obtaining Shorewood stock was not the status of a Water Co. shareholder, but rather the status of a holder of warrants which may, or may not, have been obtained by reason of Water Co. stock ownership. See Commissioner v. Gordon, 382 F.2d 499, 513 (2d Cir. 1967) (Judge Friendly’s dissenting opinion). Indeed, while it is not certain from the record, it is certainly probable that many of the warrants sold over the counter went into nonshareholder hands.2 How can it be claimed that the exchange, between Water Co. and a nonshareholder third party, of Shorewood shares in return for $5 and two warrants was “actually” a distribution to a distributing corporation shareholder with respect to his stock? A second point: Even assuming that an integrated transaction took place, petitioners still fail to meet the narrow requirements of section 355. Section 355(a)(1)(A) requires, in relevant part, that only stock of a controlled corporation may be distributed to the shareholders of the distributing corporation with respect to their stock in the distributing corporation. This may be thought of as the “to whom” of the distribution requirement. Section 355(a)(1)(D) describes what has to be distributed. That subpara-graph requires that,, at a minimum, stock constituting “control” of the controlled corporation within the meaning of section 368(c) must be distributed to shareholders of the distributing corporation. I do not believe that, on this record, we know to whom “control” was “distributed.” Of the 1,336,921 shares of Shorewood issued and outstanding after the transaction under consideration, Water Co. retained 267,384 shares or exactly 20 percent, less 1 share, of the total. It must, therefore, have distributed a shade more than 80 percent, as is found by the majority. But the statute, when “applied with precision” (Commissioner v. Gordon, 391 U.S. at 92-93), does not merely require a “distribution” — it requires distribution of “control.” Beyond that, it requires distribution of control to shareholders of the distributing corporation. Sec. 355(a)(1)(A) and (D). But apparently there was no distribution of “control” to anyone herein, let alone Water Co.’s shareholders, because “control” was presumably destroyed by the transfer itself. The majority found that Water Co. kept 267,384 shares of Shorewood common. It also found that “shareholders or their transferees or assignees subscribed to all 1,069,537 Shorewood shares offered, except for 50,000 shares acquired by the underwriters.” (Emphasis added.) Redding v. Commissioner, supra at 600. The clear import of the language is that at most, assuming that all the warrant transferees were also shareholders, 1,069,537 less 50,000 shares, or 1,019,537 shares, were acquired by Water Co. shareholders. This is approximately 76.26 percent of all the Shorewood shares issued and is not “control” within the meaning of section 368(c). In order to sustain the Court’s decision herein one would have not only to ignore the substance and importance of the rights issuance, but also assume that all the rights traded over the counter and all the underwriters were also Water Co. shareholders. I cannot join in this assumption and it seems, in any event, to be contrary to the above-quoted language. The petitioner has not shown to whom Water Co. transferred “control” inasmuch as no one related group of distributees had 80 percent of Shorewood’s stock immediately after the transfer. It is not this Court’s function to assume petitioners’ prima facie case. Rather, such case must be proven. To summarize, I do not believe that two legally freestanding steps can be run together and I am of the opinion that the realities are that the Shorewood stock was distributed with respect to warrants and not with respect to stock of Water Co. Hence the. provisions of section 355(a)(1)(A) are not met. Furthermore, and in part for the same reason, I am unable to conclude from the record herein that Water Co. distributed, with respect to its stock, 80 percent of Shorewood to its shareholders in conformance with the requirements of section 355(a)(1)(A) and (D).  If the transaction is viewed as the issuance by Shorewood of its stock through the medium of Water Co. acting as a conduit, then only this sale of the 213,907 Shorewood shares already owned by Water Co. could produce gain. Sec. 1032.    2Under any circumstance, it was the petitioners’ burden to prove that the probability did not occur. This they did not do.