Court Opinion

ID: 9453992
Source: CourtListenerOpinion
Date Created: 2023-08-04 18:31:40.997758+00
Date Added: 2024-06-11T17:33:54.742424
License: Public Domain

COLLINS, Judge
(dissenting).
I respectfully dissent from the decision of the majority. I cannot agree that the subcontracting business of KRS was “completely liquidated” within the meaning of section 331 of the Internal Revenue Code. Therefore, though I might otherwise accept the court’s treatment of the reorganization issue, I do not think it necessary to reach that question. Plaintiff’s retreat positions — (1) that the distributions in question were in partial liquidation of the corporation under sections 346 and 331(a) (2); and (2) that the distributions were not “substantially equivalent” to dividends — are, in my opinion, also without merit. Since the distributions of the earnings and profits of KRS consequently do not fit within any of the exceptions to section 301, it is my opinion that the distributions to plaintiff should be taxed as dividends at ordinary income rates, as provided in that section.
I
As found by the commissioner, KRS was primarily engaged in the business of carpentry subcontracting from December 1957 until at least July 1960. Subsequent to the formation of KEB in July 1960, however, KRS phased out its carpentry subcontracting business in favor primarily of large public contracts. KEB, on the other hand, perpetuated the type of subcontracting business previously engaged in by KRS. Whether in accordance with a plan or not, some of the assets of KRS necessary to the operation of the subcontracting business were transferred to KEB (see finding No. 28); the initiative and experience of Mr. Simon followed the subcontracting business into the hands of KEB; and the labor force, goodwill, and prior business contacts of KRS were all inherited by KEB. KRS and its second business, large-scale contracting, were terminated on August 14, 1961.
It is essential to note that the accumulated earnings and profits of KRS were almost exlusively the result of the carpentry subcontracting business. Indeed, the efforts of KRS subsequent to July 1960 to engage in the business of performing large-scale contracts were so unsuccessful that large losses were the result. Consequently, when KRS was finally dissolved, the distributions to the shareholders were all, or nearly all, accumulated earnings and profits from the carpentry subcontracting business.
The first issue to be determined, then, is whether KRS can be said to have “completely liquidated” its carpentry subcontracting business (so that the distributed earnings and profits attributable to that business would receive capital gains treatment under section 331) when KEB perpetuated that business and when both corporations were under the same effective ownership and control.
Section 331(a) (1) provides that
* * * Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock.
Section 331(b) provides that section 301 (which states the general rule that corporate distributions are dividends in the hands of the shareholders) shall not generally apply to distributions in comlete liquidation of a corporation. But, unfortunately, Congress did not choose to define the term “complete liquidation” anywhere in the Code. The legislative history of section 331, however, as well as pertinent regulations, indicates clearly, in my opinion, the interpretation we should place upon that term when, as here, it has been found that the allegedly *283liquidated business of a corporation is being carried on in substantially the same form by another corporation under the same basic control as the first (see findings Nos. 10, 26(c), 69(f)).
Congress enacted tax legislation uniquely applicable to distributions in corporate liquidation for the first time in 1924.1 The Senate Report accompanying the bill stated that
* * * A liquidating dividend is, in effect, a sale by the stockholder of his stock to the corporation; he surrenders his interest in the corporation and receives money in place thereof. Treating such a transaction as a sale and within the capital gain provisions is consistent with the entire theory of the act * * *.2
It is important to note that the report placed emphasis on both the cessation of the shareholder’s interest and the consistency between taxing liquidation distributions at capital gains rates and the overall policy of the tax law.
In 1954, in preparing the new revenue code for consideration by the Congress, the conference committee rejected a proposal in the House bill3 which would have prohibited withdrawal of corporate earnings and profits at capital gains rates by liquidation followed by reincorporation :
* * * It is the belief of the managers on the part of the House that, at the present time, the possibility of tax avoidance in this [liquidation-reincorporation] area is not sufficiently serious to require a special statutory provision. It is believed that this possibility can appropriately be disposed of by judicial decision or by regulation within the framework of the other provisions of the bill. * * * 4
Thus, not only did Congress recognize the possibility of tax avoidance by liquidation followed by reincorporation, but it specifically placed the burden of preventing such avoidance upon the courts.5
As the structure of the tax law indicates, Congress intended, as a general rule, to treat corporate distributions as dividends, taxable at ordinary income rates. So long as a shareholder retains his equity in a corporation, the returns produced by his investment will be taxable as ordinary income. As an incentive to investment, however, Congress has provided, as a privilege, an exception to the general rule. A special tax rate is generally applied to the distributions over and above a shareholder’s equity received by him at the time his interest in the business is terminated, whether by sale to the corporation or a third party or by liquidation. Therefore, the fact that a shareholder is “getting out of the business” has been an implicit and underlying prerequisite to the favorable tax treatment of distributions in liquidation of a corporation.6
In the instant case, Simon owned by far the greatest amount of stock in both KRS and KEB. When the subcontracting business was transferred from KRS to KEB, Simon continued to control that business and to receive returns upon his investment in it as fully as if KRS had never given it up. Therefore, whether *284it was intended or “planned” or not, since the business was still being carried on, the distribution of the accumulated earnings and profits of the subcontracting business — albeit delayed until the formal dissolution of KRS — was in substance no different than a distribution made by KRS would have been if made while it was carrying on that business itself. Therefore, the decision of the majority in this case permits a bail-out at capital gains rates of earnings and profits which, in my opinion, Congress intended should be taxed at ordinary income rates. To hold as the majority does defeats the policy underlying the applicable statutes.
To rely on mere form here is to ignore the substance of the transactions involved. The subcontracting business was transferred from one corporation effectively owned and controlled by Simon to another. The profits from that business were distributed to its shareholders. The formal elements of the situation here were (1) the postponement of the distribution of the assets until the formal dissolution of KRS;7 (2) the existence of KEB prior to the dissolution of KRS, instead of its creation thereafter; and (3) the continuation of KRS in form after its cessation of the carpentry business. None of these elements change the substance of what happened for tax purposes. To allow the mere dissolution of KRS, the vehicle by which the earnings and profits of the subcontracting business were distributed, to control the tax treatment of the distributions to plaintiff would defeat congressional policy as I interpret it.
Four courts have considered analogous “liquidation-reincorporation” problems. Two of them, the Tax Court and the Second Circuit Court of Appeals,8 have viewed the mere dissolution of the corporation under applicable state law as sufficient for purposes of section 331. In the other two cases,9 the Fourth and Fifth Circuit Courts of Appeals felt bound to effectuate what they felt to be controlling congressional policy and refused to accept as sufficient in this context the dissolution of the corporation under state law. For the reasons stated above, I am compelled to follow the latter approach.
Had the ownership and control of both corporations here been appreciably different, or, for example, had the subcontracting business been stopped altogether and then revived at a later date,10 the result I think appropriate here might not have been correct. In either hypothetical situation, it is conceivable that the operation of the subcontracting business by the first corporation may have been sufficiently unconnected with the business in the hands of the second corporation that the business as originally operated could be deemed to be “completely liquidated.”
Whether a business is completely liquidated in any particular case, however, will depend, on its unique facts, such as, for example, the ownership and control structures of the corporations involved. Similarly, the existence of “good business reasons” may at times be important to the objective resolution of the question. I do not purport, however, to decide any case but the one before us. The subcontracting business under consideration here was never terminated in substance, but was merely embodied within a different corporate shell. The facts of this case establish business continuity so clearly that the existence or nonexistence of good business reasons is unhelpful, if not immaterial.
For the reasons stated above, I believe that, to be consistent with con*285gressional policy, we cannot find that KRS "completely liquidated" its carpentry subcontracting business, and I would therefore hold that all earnings and profits distributed by KRS upon its dissolution which were attributable to the subcontracting business cannot be given capital gains treatment under section 331.
II
Plaintiff's contention that the dis~ributions in issue should be taxed at capital gains rates because they were in partial liquidation of the corporation under sections 331(a) (2) and 346 is without merit. Distributions are usually deemed to be in partial liquidation of a corporation when effected for purposes of corporate contraction, but without termination of the corporate operations.11 As the statute indicates on its face, the existence of a partial liquidation is determined by an examination of transactions at the corporate level, as opposed to a consideration of the effect such actions might have upon any particular shareholder. Under the facts, the distributions in question were clearly not part of a "series of distributions in redemption of all of the stock of the corporation pursuant to a plan," so as to qualify under section 346(a) (1). Moreover, the distributions were not in redemption of part of the stock pursuant to a plan under section 346(a) (2), nor was the corporation engaged, immediately after the termination of the subcontracting business, in a trade or business actively conducted in any appreciable way within the 5 years preceding the dissolution. KRS became actively involved in large-scale contracts only subsequent to July 1960. Therefore, the requirements of section 346(b) (2) are not met. I would therefore find that no partial liquidation of KRS occurred.
III
I would also hold that plaintiff's assertions that the distributions were not essentially equivalent to dividends under section 302(b) (1) (so that they would be viewed as being in exchange for stock under section 302(a)) are also without merit. Whether distributions within the ambit of section 331, but which do not qualify as being in complete liquidation of a corporation, can ever be treated under section 302 is open to question. That question need not be decided here, however, since plaintiff can in no way avail himself of the "safe harbors" of section 302(b).
In the first place, as stated in part I of this opinion, it is believed that the distributions in question were identical in effect (because of the continuity of the business and its ownership and control) to dividends KRS might have paid while operating the subcontracting business. Therefore, noncompliance with the conditions of section 302(b) (1) would seem to bar plaintiff's recovery.
Secondly, under the constructive ownership of stock rules of section 318(a), applicable to plaintiff through the exception in section 302(c) (2) (B) to the exception in section 302(c) (2) (A) to the general rule stated in section 302(c) (1), plaintiff trust was identified with Mr. Simon in his ownership and control of KRS. Since, as I would have held, policy considerations prohibit a finding that KRS was completely liquidated, plaintiff-identified with Simon in his continuity of interest and control-should not be permitted to avoid the impact of that finding and to defeat what I believe to be the intent of Congress by receiving capital gains treatment under section 302. Therefore, despite the fact that plaintiff might appear to be within the terms of section 302(b) (3), recognition and enforcement of the controlling tax policy require a finding that the distributions were substantially equivalent to dividends.
CONCLUSION
For the reasons stated, I would find that the subcontracting business of KRS was not completely liquidated in terms of section 331 and that the dis*286tributions to plaintiff were not in partial liquidation of the corporation, but were substantially equivalent to dividends. I would therefore rule for defendant and permit the taxation of the KRS distributions to plaintiff trust at ordinary income rates.
APPENDIX
INTERNAL REVENUE CODE OF 1954:
SEC. 301. DISTRIBUTIONS OF PROPERTY.
(a) In General. — Except as otherwise provided in this chapter, a distribution of property (as defined in section 317 (a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c). ******
(c) Amount Taxable. — In the case of a distribution to which subsection (a) applies—
(1) Amount constituting dividend.— That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income. ******
(26 U.S.C. 1964 ed., Sec. 301.)
SEC. 302. DISTRIBUTIONS IN REDEMPTION OF STOCK.
(a) General Rule. — If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.
(b) Redemptions Treated as Exchanges.—
(1) Redemptions not equivalent to dividends. — Subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.
******
(d) Redemptions Treated as Distributions of Property. — Except as otherwise provided in this subchapter, if a corporation redeems its stock (within the meaning of section 317(b)), and if subsection (a) of this section does not apply, such redemption shall be treated as a distribution of property to which section 301 applies.
******
(26 U.S.C. 1964 ed., Sec. 302.)
SEC. 316. DIVIDEND DEFINED.
(a) General Rule. — For purposes of this subtitle, the term “dividend” means any distribution of property made by a corporation to its shareholders—
(1) out of its earnings and profits accumulated after February 28, 1913, or
(2) out of its earnings and profits of the taxable year * * *
Except as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits. * * * ******
(26 U.S.C. 1964 ed., Sec. 316.)
SEC. 317. OTHER DEFINITIONS.
******
(b) Redemption of Stock. — For purposes of this part, stock shall be treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.
******
(26 U.S.C. 1964 ed., Sec. 317.)
SEC. 331. GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS
(a) General Rule.—
(1) Complete liquidations. — Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock. ******
(b) Nonapplication of Section SOI.— Section 301 (relating to effects on shareholder of distributions of property) shall not apply to any distribution of property * * * in partial or complete liquidation.
******
(26 U.S.C. 1964 ed., Sec. 331.)
*287SEC. 354. EXCHANGES OF STOCK AND SECURITIES IN CERTAIN REORGANIZATIONS.
(a) General Rule.—
(1) In general. — No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.
******
(3) Cross reference.— * * *
(b) Exception.—
(1) In general. — Subsection (a) shall not apply to an exchange in pursuance of a plan of reorganization within the meaning of section 368(a) (1) (D), unless—
(A) the corporation to which the assets are transferred acquires substantially all of the assets of the transfer- or of such assets; and
(B) the stock, securities, and other properties received by such transferor, as well as the other properties of such transferor, are distributed in pursuance of the plan of reorganization.
******
(26 U.S.C. 1964 ed., Sec. 354.)
SEC. 356. RECEIPT OF ADDITIONAL CONSIDERATION.
(a) Gain on Exchanges.—
(1) Recognition of gain. — If—
(A) section 354 or 355 would apply to an exchange but for the fact that
(B) the property received in the exchange consists not only of property permitted by section 354 or 355 to be received without the recognition of gain but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.
(2) Treatment as dividend. — If an exchange is described in paragraph (1) but has the effect of the distribution of a dividend, then there shall be treated as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be treated as gain from the exchange of property. ******
(26 U.S.C. 1964 ed., Sec. 356.)
SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.
(a) Reorganization.—
(1) In general. — For purposes of parts I and II and this part, the term “reorganization” means—
******
(D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356;
******
(26 U.S.C.1964 ed., Sec. 368.)
TREASURY REGULATIONS ON INCOME TAX (1954 Code):
SEC. 1.301-1 RULES APPLICABLE WITH RESPECT TO DISTRIBUTIONS OF MONEY AND OTHER PROPERTY.
******
(e) Transactions treated as distributions. A distribution to shareholders with respect to their stock is within the terms of section 301 although it takes place at the same time as another transaction if the distribution is in substance a separate transaction whether or not connected in a formal sense. This is *288most likely to occur in the case of a recapitalization, a reincorporation, or a merger of a corporation with a newly organized corporation having substantially no property. * * *
******
(26 C.F.R., Sec. 1.301-1.)
SEC. 1.331-1 CORPORATE LIQUIDATIONS. * * *
******
(c) A liquidation which is followed by a transfer to another corporation of all or part of the assets of the liquidating corporation or which is preceded by such a transfer may, however, have the effect of the distribution of a dividend or of a transaction in which no loss is recognized and gain is recognized only to the extent of “other property.” See sections 301 and 356.
******
(26 C.F.R., Sec. 1.331-1.)

. Revenue Act of 1924, ch. 234, § 201, 43 Stat. 253.

. S.Rep.No. 398, 68th Cong., 1st Sess. 11-12 (1924).

. See H.R.Rep.No. 1337, 83d Cong., 2d Sess. 40 (1954), U.S.Code Cong. & Admin.News 1954, p. 4025.

. H.R.Conf.Rep.No. 2543, 83d Cong., 2d Sess. 41 (1954), U.S.Code Cong. & Admin.News 1954, p. 5301.

. In recognizing the congressional directive, the Internal Revenue Service has promulgated the following regulation: “A liquidation which is followed by a transfer to another corporation of all or part of the assets of the liquidating corporation or which is preceded by such a transfer may, however, have the effect of the distribution of a dividend * * Treas.Reg. § 1.331-1 (c) (1955).

. See text at note 2 supra; Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, 338-39, 349-50 (2d ed.1966).

. See Bittker & Eustice, supra note 6, at 340-41.

. Commissioner v. Berghash, 361 F.2d 257 (2d Cir. 1966) ; Joseph C. Gallagher, 39 T.C. 144 (1962).

. Davant v. Commissioner of Internal Revenue, 366 F.2d 874 (5th Cir. 1966), cert. denied, 386 U.S. 1022, 87 S.Ct. 1370, 18 L.Ed.2d 460 (1967); Pridemark, Inc. v. Commissioner of Internal Revenue, 345 F.2d 35 (4th Cir. 1965).

. Cf. Pridemark, Inc. v. Commissioner of Internal Revenue, 345 F.2d 35 (4th Cir. 1965).

. See Bittker & Eustice, supra note 6, at 275-77.