Southwest Natural Gas Co. v. Commissioner of Internal Revenue , 189 F.2d 332 ( 1951 )

RUSSELL, Circuit Judge.

The correctness of asserted deficiencies for corporate income tax for the year 1941 and of declared value excess profits tax and excess profits tax for 1942 due by Southwest Natural Gas Company depends upon whether a merger of Peoples Gas & Fuel Corporation with the taxpayer, effected in accordance with the laws of Delaware, was a sale, as asserted by the Commissioner, or a “reorganization” within the terms of Section 112(g) of the Internal Revenue Code,¹ as contended by the taxpayer. The parties so stipulated the issue in the Tax Court.² That Court upheld the Commissioner’s determination. Southwest Natural Gas Company has petitioned this Court for review.

The facts found by the Tax Court (which, as facts, are not challenged) and the grounds for its judgment in law thereon are fully set forth in its published opinion.³ In substance that Court held that literal compliance with the provisions of a state law authorizing a merger would not in itself effect a “reorganization” within the terms applicable under Internal Revenue Statutes; that the test of continuity of interest was nevertheless applicable; and that the transaction in question did not meet this test. This ruling is assigned as error upon grounds which, while variously stated, require for their maintenance establishment of at least one of the propositions that: if the literal language of the statute is complied with, that is if there is a “statutory merger” duly effected in accordance with state law, the statute requires it be treated as a reorganization; or, at least where such merger has been effected the Tax Court must hold the transaction a reorganization in the absence of a finding that it was not in truth and in substance a merger; or, even if this be not correct, that the facts of this case disclose sufficient “continuity of interest.” It is insisted in either view the Tax Court was required to hold under the facts found by it that the transaction in question was in truth a “statutory merger” and hence a “reorganition.”

Consideration of the underlying purposes of the terms and provisions of Section 112 of the Internal Revenue Code⁴ in its entirety and of this Section (g) (1) (A) as involved here, in particular, as being enacted “to free from the imposition of an income tax purely ‘paper profits or losses’ wherein there is no realization of gain or loss in the business sense but merely the recasting of the same interests in a different form, the tax being postponed to a future date when a more tangible gain or loss is realized.” Commissioner of Internal Revenue v. Gilmore’s Estate, 3 Cir., 130 F.2d 791, 794,⁵ and thus applicable to transactions which effect only the “readjustment of continuing interest in property under modified corporate forms,”⁶ *clearly discloses, we think, that the accomplishment of a statutory merger does not ipso facto constitute a “reorganization” within the terms of the statute here involved. This has been expressly held by the Court of Appeals for the Third Circuit in a well considered opinion, supported by numerous authorities cited. Roebling v. Commissioner, 143 F.2d 810. There is no occasion for elaboration or reiteration of the reasoning and authorities set forth in that opinion. In Bazley v. Commissioner, 331 U.S. 737, 67 S.Ct. 1489, 1491, 91 L.Ed. 1782, the Supreme Court enforced a similar construction with reference to the “re-capitalization” provision of the section. The authorities are clearly to the effect that the terms expressed in the statute are not to be given merely a literal interpretation but are to be considered and applied in accordance with the purpose of Section 112. Thus the benefits of the reorganization provision have been withheld “in situations which might have satisfied provisions of the section treated as inert language, because they were not reorganizations of the kind with which § 112, in its purpose and particulars concerns itself. See Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462, 53 S.Ct. 257, 77 L.Ed. 428; Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266 79, L.Ed. 596; LeTulle v. Scofield, 308 U.S. 415, 60 S.Ct. 313, 84 L.Ed. 355.” Bazley v. Commissioner, supra.

It is thus clear that the test of “continuity of interest” announced and applied by these cited authorities, supra, must be met before a statutory merger may properly be held a reorganization within the terms of Section 112(g)(1)(A), supra. Each case must in its final analysis be controlled by its own peculiar facts.⁷ While no precise formula has been expressed for determining whether there has been retention of the requisite interest, it seems clear that the requirement of continuity of interest consistent with the statutory intent is not fulfilled in the absence of a showing: (1) that the transferorcorporation or its shareholders retained a. substantial proprietary stake in the enterprise represented by a material .interest in the affairs of the transferee corporation, and, (2) that such retained interest represents a substantial part of the value of the property transferred.⁸

Among other facts, the Tax Court found' that under the merger all of Peoples’ assets were acquired by the petitioner in-exchange for specified amounts of stock, bonds, cash and the assumption of debts. There was a total of 18,875 shares common stock of Peoples’ entitled to participate under the agreement of merger. The stockholders were offered Option A and Option B. The holders of 7,690 of such shares exercised Option B of that agreement and received $30.00 in cash for each share, or a total of $230,700.00. In respect to the stock now involved, the stockholders who exercised Option A, the holders of 59.2 per cent of the common stock received in exchange 16.4 per cent of petitioner’s outstanding common stock plus $340,350.00 principal amount of six per cent mortgage bonds (of the market value of 90 per cent of principal), which had been assumed by-petitioner in a prior merger, and $17,779.59 cash. The 16.4 per cent of the common stock referred to was represented by 111,850 shares having a market value of $5,592.50, or five cents per share, and represented the continuing proprietary interest of the participating stockholders in the enterprise. This was less than one per cent of the consideration paid by the taxpayers.

We think it clear that these and other facts found by the Tax Court find substantial support in the evidence, and the conclusion of the Tax Court that they failed to evidence sufficient continuity of interest to bring the transaction within the requirements of the applicable statute is correct.

The decision of the Tax Court is

Affirmed.

1 . 26 U.S.C.A. § 112(g). “As used in this section * * * (1) The term ‘reorganization’ means (A) a statutory merger or consolidation.”

2 . Southwest Natural Gas Co. v. Commissioner of Internal Revenue, 14 T.C. 81.

3 . In argument here the Commissioner relates the transaction to Section 112(b) (4), 26 U.S.C.A. § 112(b) (4).

4 . 26 U.S.C.A. § 112.

5 . Electrical Securities Corp. v. Commissioner, 2 Cir., 92 F.2d 593, 595, “purpose of the section (112) is apparent; it was meant to allow businesses to be reconstructed when the resulting interests were substantially unchanged.”

6 . Internal Revenue Regulation 111, Section 29.112(g)-l.

7 . Muskegon Motor Specialities Co. v. Commissioner, 6 Cir., 134 F.2d 904, 907.

8 . Merten’s Law of Federal Income Taxation, Vol. 3, 1950, Cumulative Pocket Supplement Section 20.74.