Dover Corporation and Subsidiaries v. Commissioner , 122 T.C. No. 19 ( 2004 )

122 T.C. No. 19
UNITED STATES TAX COURT
DOVER CORPORATION AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12821-00. Filed May 5, 2004.
D and H, United Kingdom corporations, were
controlled foreign corporations with respect to P. H
was a wholly owned subsidiary of D. In 1997, D sold
the stock of H to an unrelated third party. In 1999, P
requested that H be granted an extension of time to
retroactively elect to be treated as a “disregarded
entity” pursuant to sec. 301.7701-3, Proced. & Admin.
Regs., effective “immediately prior to” D’s sale of the
H stock. R granted the requested extension of time on
Mar. 31, 2000. H’s retroactive disregarded entity
election was filed on or about Oct. 10, 1999. Pursuant
to that election, there was, for Federal tax purposes,
a deemed sec. 332, I.R.C., liquidation of H followed
immediately by D’s deemed sale of H’s assets, rather
than a sale by D of the H stock.
Held: In light of R’s administrative guidance
pertaining to the tax effects of a liquidation governed
by secs. 332 and 381, I.R.C., D’s deemed sale of H’s
assets constitutes a sale of property used in D’s trade
or business within the meaning of sec. 1.954-
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2(e)(3)(ii) through (iv), Income Tax Regs., with the
result that D’s gain on that sale does not constitute
Subpart F (foreign personal holding company) income to
P pursuant to sec. 954(c)(1)(B)(iii), I.R.C.
Rauenhorst v. Commissioner, 119 T.C. 157 (2002),
applied.
Robert D. Whoriskey, George Pompetzki, Eduardo A.
Cukier, and Linda Galler, for petitioner.
Lyle B. Press, for respondent.
OPINION
HALPERN, Judge: Dover Corporation (petitioner) is the
common parent of an affiliated group of corporations making a
consolidated return of income (the group or affiliated group).
By notice of deficiency dated September 14, 2000 (the notice),
respondent determined deficiencies in Federal income tax for the
group for its 1996 and 1997 taxable (calendar) years in the
amounts of $9,329,596 and $24,422,581, respectively. All but one
of the adjustments that gave rise to those determinations have
been settled, and this report addresses the sole remaining issue,
which involves an interaction between the so-called check-the-box
regulations and the definition of foreign personal holding
company income (FPHCI); viz, whether the deemed sale of assets
immediately following their deemed receipt (pursuant to the
check-the-box regulations) from a disregarded foreign entity
gives rise to FPHCI.
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Unless otherwise stated, all section references are to the
Internal Revenue Code in effect for 1997, the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
Background
Introduction
This case was submitted for decision without trial pursuant
to Rule 122. Facts stipulated by the parties are so found. The
stipulation of facts filed by the parties, with attached
exhibits, is included herein by this reference. Respondent
objects, on the grounds of relevance, to 26 exhibits referenced
in certain of the stipulations. See the discussion infra section
IV.
Petitioner is a Delaware corporation, whose shares are
publicly traded and which maintains its principal place of
business in New York, New York.
Business Activities of the Affiliated Group
Together, the affiliated group is a diversified industrial
manufacturer, producing through its members and foreign
subsidiaries a broad range of products and sophisticated
manufacturing equipment for other industries and businesses.
During and prior to 1997, the group’s business activities were
divided into five business groups, one of which was known as
Dover Elevator.
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Dover Elevator
Dover Elevator, like each of the other business groups, was
managed by a headquarters corporation, Dover Elevator
International, Inc. (DEI), a domestic corporation. However, not
all of the corporations that constituted Dover Elevator were
direct or indirect subsidiaries of DEI. During 1997, DEI’s
United Kingdom (UK) elevator business was conducted by Hammond &
Champness Limited (H&C), a UK corporation engaged in the business
of installing and servicing elevators. H&C was wholly owned by a
UK holding company, Dover U.K. Holdings Limited (Dover UK), which
was wholly owned by a Delaware corporation, Delaware Capital
Formation (DCF), which, finally, was wholly owned by petitioner.
Sale of H&C
On June 30, 1997, Dover UK and petitioner entered into an
agreement with Thyssen Industrie Holdings U.K. PLC (Thyssen), a
German corporation registered in England and Wales, and its
German parent, Thyssen Industrie AG, for the sale by Dover UK to
Thyssen of the entire issued share capital of H&C (the agreement
or stock sale agreement). The agreement provided that it and
other specified documents and agreements relating to the sale
were to be held in escrow until the “Escrow Release Date” (July
11, 1997), by which time it was anticipated that the purchaser
would have “completed its due diligence inquiries, and * * *
determined that it does wish to proceed with * * * [the sale]”
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(the “escrow condition”). Dover UK, as “Vendor”, also agreed to
accomplish certain document deliveries and undertakings by July
11, at which time Thyssen, as “Purchaser”, was required to
“satisfy the consideration for the Shares”. Dover UK also agreed
to carry on the H&C business “in the normal course without any
interruption” between June 30 and July 11, 1997. On July 11,
1997, Thyssen notified Dover UK that the escrow condition had
been satisfied, and (we assume, since there is no stipulation)
the purchase price was received by Dover.1
Petitioner obtained an opinion of UK counsel dated July 3,
2001, that, as a matter of English law, beneficial title to the
H&C shares passed from Dover UK to Thyssen on July 11, 1997, when
the escrow condition was satisfied.
Retroactive Election To Treat H&C as a Disregarded Entity
By letter dated December 3, 1998, petitioner, on behalf of
its (then) former indirect subsidiary, H&C, requested that
respondent grant an extension of time, pursuant to sections
301.9100-1(c) and 301.9100-3, Proced. & Admin. Regs., for H&C to
file a retroactive election to be a disregarded entity for
Federal tax purposes (the request for 9100 relief).
1
DEI sold its German elevator service subsidiaries to
Thyssen effective June 1, 1997, and members of the affiliated
group sold the remainder of the group’s elevator business, within
and without the United States, to Thyssen Industrie AG and
Thyssen Elevator Holding Corp. in January 1999. Thus, in a
series of three transactions, the Thyssen group purchased the
group’s worldwide elevator business.
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Specifically, petitioner requested: “H&C be granted an extension
of time to make an election: (a) * * * to be disregarded as an
entity separate from its owner for U.S. tax purposes and (b)
effective immediately prior to the sale of stock in H&C by Dover
UK to Thyssen UK.”2 In the request for 9100 relief, petitioner
stated that the date of the sale was June 30, 1997, and, on the
Form 8832, Entity Classification Election (Form 8832), attached
to the request for 9100 relief, it set forth June 30, 1997, as
the proposed effective date of the election.
Initially, respondent was reluctant to grant the request for
9100 relief, in large part, because, in respondent’s view,
petitioner should not be entitled to benefits it might claim
resulted from the disregarded entity election; i.e., the
avoidance of FPHCI on the deemed sale of the H&C assets.
However, after representatives of petitioner and respondent
conferred, and petitioner made a supplemental submission,
respondent, on March 31, 2000, granted the requested relief.
Specifically, respondent granted to H&C “an extension of time for
making the election to be disregarded as an entity separate from
2
Pursuant to sec. 301.7701-3(c)(1)(iii), Proced. & Admin.
Regs., H&C could have made the election to be a disregarded
entity at any time within 75 days after the date (June 30, 1997),
specified on the election form (Form 8832, Entity Classification
Election). Because petitioner inadvertently missed that
deadline, it was required to request an extension of time,
pursuant to secs. 301.9100-1(c) and 301.9100-3, Proced. & Admin.
Regs., to make the election.
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its owner for federal tax purposes, effective immediately prior
to the sale on * * * [June 30, 19973], until 60 days following
the date of this letter.” Respondent, however, added the
following caveat:
no inference should be drawn from this letter that any
gain from the sale of * * * [H&C’s] assets immediately
following its election to be disregarded as an entity
separate from its owner gives rise to gain that is not
foreign personal holding company income as defined in
section 954(c)(1)(B) of the Internal Revenue Code.
On or about October 10, 1999, H&C made an election on Form
8832 to be disregarded as a separate entity. The Form 8832
specifies that the election is to be effective beginning June 30,
1997.
Discussion
I. Introduction
This case presents an issue of first impression and, insofar
as we are aware, the first occasion that any court has had to
opine on the impact of the so-called check-the-box regulations on
the application of a specific provision of the Internal Revenue
Code of 1986 (the Code), in this case, section 954(c)(1)(B)(iii)
(defining, in part, FPHCI).4
3
Based upon petitioner’s representation, that is the
assumed date of the sale of the H&C stock by Dover UK.
4
There has, however, been much commentary concerning the
issue before us today. E.g., Sheppard, “Behind the Eight Ball on
Check-the-Box Abuses”, 101 Tax Notes 437 (Oct. 27, 2003); Yoder &
Everson, “Check-and-Sell Transactions: Proposed Regulations
(continued...)
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II. Code and Regulations
A. The Code
The provision of the Code principally at issue is section
954. Section 954 is found in subpart F of part III, subchapter
N, chapter 1, subtitle A of the Code (Subpart F), which
encompasses sections 951-964. Subpart F is concerned with
controlled foreign corporations (CFCs). Neither party disputes
that, in 1997, both Dover UK and H&C (up until it became a
disregarded entity) were CFCs, as that term is defined in section
957(a). Section 951 provides that each United States shareholder
of a CFC shall include in gross income certain amounts, including
“his pro rata share * * * of the * * * [CFC’s] subpart F income”
for the taxable year. Sec. 951(a)(1)(A)(i).5 Subpart F income
includes “foreign base company income (as determined under
section 954)”. Sec. 952(a)(2). Pursuant to section 954(a)(1),
foreign base company income includes FPHCI, which is defined, in
pertinent part, in section 954(c) as follows:
(c) Foreign Personal Holding Company Income.--
(1) In general.--For purposes of subsection (a)(1), the
term “foreign personal holding company income” means the
4
(...continued)
Withdrawn, But Still Under Attack”, 32 Tax Mgmt. Int. J. 515
(Oct. 10, 2003); Click, “Treasury Withdraws Extraordinary Check-
the-Box Regulations”, 101 Tax Notes 95 (Oct. 6, 2003).
5
The parties do not dispute that petitioner constituted a
“United States shareholder”, as defined in sec. 951(b), with
respect to Dover UK on the date of the sale of the H&C stock.
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portion of the gross income which consists of:
* * * * * * *
(B) Certain property transactions.--The
excess of gains over losses from the sale or
exchange of property--
* * * * * * *
(iii) which does not give rise to any income.
B. The Regulations
1. Regulations Under Section 954(c)(1)(B)(iii)
In pertinent part, section 1.954-2(e)(3), Income Tax Regs.,
which defines “property that does not give rise to income”,
provides:
(3) Property that does not give rise to income.
Except as otherwise provided in this paragraph (e)(3),
for purposes of this section, the term property that
does not give rise to income includes all rights and
interests in property (whether or not a capital asset)
including, for example, forwards, futures and options.
Property that does not give rise to income shall not
include--
* * * * * * *
(ii) Tangible property (other than real
property) used or held for use in the
controlled foreign corporation’s trade or
business that is of a character that would be
subject to the allowance for depreciation
under section 167 or 168 and the regulations
under those sections (including tangible
property described in section 1.167(a)-2);
(iii) Real property that does not give
rise to rental or similar income, to the
extent used or held for use in the controlled
foreign corporation’s trade or business;
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(iv) Intangible property (as defined in
section 936(h)(3)(B)), goodwill or going
concern value, to the extent used or held for
use in the controlled foreign corporation’s
trade or business[.]
In pertinent part, section 1.954-2(a)(3), Income Tax Regs.,
provides: “The use * * * for which property is held is that use *
* * for which it was held for more than one-half of the period
during which the controlled foreign corporation held the property
prior to the disposition.”
2. The Check-the-Box Regulations
a. Development and Issuance of the Regulations
The Commissioner announced, in Notice 95-14, 1995-1 C.B.
297, that the Internal Revenue Service (IRS) and the Department
of the Treasury (Treasury) were considering simplifying the
entity classification regulations to allow taxpayers to treat
both domestic (unincorporated) and foreign business organizations
as partnerships or associations (generally taxable as
corporations) on an elective basis. In Notice 95-14, the
Commissioner justified the proposed radical departure from the
existing classification regulations by observing that, as a
“consequence of the narrowing of the differences under local law
between corporations and partnerships * * * taxpayers can achieve
partnership tax classification for a non-publicly traded
organization that, in all meaningful respects, is virtually
indistinguishable from a corporation.” Id. The Commissioner
 - 11 -
further observed that the proliferation of revenue rulings,
revenue procedures, and letter rulings determining or relating to
the classification for Federal tax purposes of limited liability
companies and partnerships formed under State law had made the
existing classification regulations unnecessarily cumbersome to
administer, and the resulting complexities risked leaving small
unincorporated organizations with insufficient resources and
expertise to apply the current classification regulation to
achieve the organization’s desired classification. Id. The
Commissioner also stated that, because the same types of concerns
“are mirrored in the foreign context,” the IRS and Treasury “are
considering simplifying the classification rules for foreign
organizations”. Id. at 298. Notice 95-14 invited comments and
scheduled a public hearing. Id. at 299.
In 1996, the written comments and public hearing were
followed by the issuance of, first, proposed and, then, final
classification regulations. See PS-43-95, Proposed Income Tax
Regs., 61 Fed. Reg. 21989 (May 13, 1996) (the proposed
regulations); T.D. 8697 (December 18, 1996), 1997-1 C.B. 215 (the
final regulations). The classification regulations are commonly
referred to as the “check-the-box” regulations because of their
elective feature. See, e.g., Schler, “Initial Thoughts on the
Proposed ‘Check-the-Box’ Regulations”, 71 Tax Notes 1679 (June
17, 1996).
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Not only did both sets of regulations permit most domestic
(unincorporated) and foreign business organizations to elect
between association and partnership classification for Federal
tax purposes, as first proposed in Notice 95-14,6 but, of
particular relevance to this case, they both extended the
elective regime to single-owner organizations. Under the final
regulations, single-owner organizations are permitted to elect
“to be recognized or disregarded as entities separate from their
owners.” Sec. 301.7701-1(a)(4), Proced. & Admin. Regs.
The final regulations became effective as of January 1,
1997, with a special transition rule for existing entities. T.D.
8697, 1997-1 C.B. at 219.7
6
The final regulations provide a list of organizations
(substantially the same as those listed in the proposed
regulations) formed under foreign (or U.S. possession) law that,
subject to certain grandfather rules, are treated as per se
corporations. See sec. 301.7701-2(b)(8), (d), Proced. & Admin.
Regs. In general, the list includes the publicly traded, limited
liability organization that may be formed under the law of each
country or possession. The per se corporation under United
Kingdom law is a public limited company. H&C was not such a
company.
7
The check-the-box regulations, like the classification
regulations that they replaced, were issued under sec. 7701(a)(2)
and (3), which defines the terms “partnership” and “corporation”.
Some commentators have questioned whether the regulations
constitute a valid exercise of the Treasury Secretary’s
authority under sec. 7805(a) to issue interpretive regulations.
See, e.g., Staff of Joint Committee on Taxation, Review of
Selected Entity Classification and Partnership Tax Issues, at
13-17 (J. Comm. Print Apr. 18, 1997); McKee et al., Federal
Taxation of Partnerships and Partners, par. 3.08 at 3-102 (3d ed.
1997); Dougan et al., “Check The Box”--Looking Under The Lid, 75
(continued...)
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The preamble to the final regulations contains the following
warning to taxpayers:
in light of the increased flexibility under an elective
regime for the creation of organizations classified as
partnerships, Treasury and the IRS will continue to
monitor carefully the uses of partnerships in the
international context and will take appropriate action
when partnerships are used to achieve results that are
inconsistent with the policies and rules of particular
Code provisions or of U.S. tax treaties. [T.D. 8697,
1997-1 C.B. at 216.]
The preamble to the proposed regulations contains a substantially
identical warning, except that the promise is to “issue
appropriate substantive guidance” rather than “take appropriate
action” with regard to the use of partnerships for what Treasury
and IRS consider improper purposes in the international context.
See 61 Fed. Reg. at 21990 (May 13, 1996). We surmise that the
change in language signaled an intent not only to address
perceived abuses in the use of partnerships in amended
regulations, revenue rulings, or other public pronouncements
that, generally, would have prospective effect but also to
challenge those perceived abuses on audit. For no apparent
reason, the warning did not extend to allegedly inappropriate
uses of disregarded entities, the type of organization involved
in this case.
7
(...continued)
Tax Notes 1141, 1143-1144 (May 26, 1997); Mundstock, A Unified
Approach To Subchapters K & S, 11 n.35 (2002). Neither party has
challenged the validity of all or any portion of the regulations.
Therefore, for purposes of this case, we accept (without
deciding) that the regulations are valid.
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b. Amendments to the Regulations
Since they were issued, the (final) check-the-box
regulations have been amended several times. The only relevant
amendments were additions to the regulations that, together,
constitute the existing paragraph (g) of section 301.7701-3,
Proced. & Admin. Regs. See T.D. 8844, 1999-2 C.B. 661, 666-667;
T.D. 8970, 2002-1 C.B. 281, 282. Although those amendments are
generally effective as of the dates of issuance (November 29,
1999, and December 17, 2001, respectively), both amendments
provide for retroactive application for elections filed before
those dates if all affected persons take consistent filing
positions. See sec. 301.7701-3(g)(2)(ii), (4), Proced. & Admin.
Regs. The parties have stipulated that the election by H&C, on
Form 8832, to be a disregarded entity was filed on or about
October 10, 1999, which precedes the general effective dates.
On brief, both parties have cited and relied upon portions of
section 301.7701-3(g), Proced. & Admin. Regs. Therefore, we find
that the parties agree to the retroactive application of
paragraph (g) of section 301.7701-3, Proced. & Admin. Regs., to
H&C’s disregarded entity election.
c. Applicable Provisions of the Regulations
Section 301.7701-3(a), Proced. & Admin. Regs., sets forth
the general rule that “[a] business entity that is not classified
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as a corporation * * * can elect its classification for federal
tax purposes as provided in this section”.
In pertinent part, section 301.7701-3(g)(1)(iii), Proced. &
Admin. Regs., provides:
(iii) Association to disregarded entity. If an
eligible entity classified as an association elects * *
* to be disregarded as an entity separate from its
owner, the following is deemed to occur: The
association distributes all of its assets and
liabilities to its single owner in liquidation of the
association.
Section 301.7701-2(a), Proced. & Admin. Regs., states that,
“if * * * [an] entity is disregarded, its activities are treated
in the same manner as a sole proprietorship, branch, or division
of the owner”.
Under section 301.7701-3(c)(1)(i), Proced. & Admin. Regs., a
classification election, including an election to change
classification, is made by filing a Form 8832 with the IRS
service center designated on that form. Under subdivision (iii),
the election is effective “on the date specified by the entity on
Form 8832" if, as in this case, one is specified.
Under section 301.7701-3(g)(3)(i), Proced. & Admin. Regs.,
an election to change classification “is treated as occurring at
the start of the day for which the election is effective”, and
“[a]ny transactions that are deemed to occur * * * as a result of
a change in classification [e.g., in the case of a change in
classification from association to disregarded entity, the deemed
liquidation] are treated as occurring immediately before the
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close of the day before the election is effective”. For example,
if H&C’s disregarded entity election is effective as of the start
of business on June 30, 1997, the deemed liquidation of H&C is
treated as occurring immediately before the close of business on
June 29, 1997.
The making of a disregarded entity election “is considered
to be the adoption of a plan of liquidation immediately before
the deemed liquidation”, thereby qualifying the parties to the
deemed liquidation for tax-free treatment under sections 332 and
337. Sec. 301.7701-3(g)(2)(ii), Proced. & Admin. Regs.
Lastly, section 301.7701-3(g)(2)(i), Proced. & Admin. Regs.,
provides:
(2) Effect of elective changes.--(i) In general.
The tax treatment of a change in the classification of
an entity for federal tax purposes by election under
paragraph (c)(1)(i) of this section is determined under
all relevant provisions of the Internal Revenue Code
and general principles of tax law, including the step
transaction doctrine.
The preamble to the 1997 proposed regulations, which contains the
identical provision, explains the purpose of the above quoted
provision:
This provision * * * is intended to ensure that the tax
consequences of an elective change will be identical to
the consequences that would have occurred if the
taxpayer had actually taken the steps described in the
* * * regulations. [REG-105162-97, 62 Fed. Reg. 55768
(Oct. 28, 1997).]
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III. Summary of the Parties’ Arguments
A. Petitioner’s Argument
Petitioner argues that, by permitting a corporate taxpayer
to “disregard” the separate entity status of a subsidiary and,
instead, treat the subsidiary’s business as a hypothetical branch
or division of the parent, the check-the-box regulations override
the principle, based upon Moline Props., Inc. v. Commissioner,
319 U.S. 436, 438-439 (1943), that the separate entity status of
a corporation may not be ignored for Federal tax purposes. As a
result (as petitioner sees it), Dover UK is deemed not only to
sell H&C’s assets (rather than its shares in H&C) but is deemed
to be engaged in H&C’s business at the time of that sale.
Therefore, petitioner argues that the H&C assets are excluded, by
section 1.954-2(e)(3)(ii) through (iv), Income Tax Regs., from
the definition of property “which does not give rise to any
income”, with the result that the deemed sale of those assets did
not give rise to FPHCI pursuant to section 954(c)(1)(B)(iii).8
Alternatively, petitioner argues that, giving effect to the
“plain and ordinary meaning” of section 954(c)(1)(B)(iii), Dover
UK’s deemed sale of the operating assets of H&C “could not
8
We find the parties to be in agreement that, whatever our
decision regarding the issue of whether Dover UK’s deemed sale of
the H&C operating assets constituted a sale of “property which
does not give rise to any income”, that decision applies to all
of H&C’s assets as of the date of the deemed asset sale to
Thyssen.
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possibly have been a sale of property ‘which does not give rise
to any income’ because those assets were components of an active,
ongoing commercial enterprise, which did give rise to income.”
Therefore, petitioner argues that, because the requirement in
section 1.954-2(e)(3)(ii) through (iv), Income Tax Regs., that
such assets be used in the seller’s trade or business goes beyond
the narrow statutory mandate that such assets simply not be
property “which does not give rise to any income”, that
regulation is invalid.
B. Respondent’s Arguments
Respondent argues that the deemed sale of the H&C operating
assets was not a sale of property used or held for use in Dover
UK’s business. Therefore, respondent continues, that property
was not excluded from the definition of property “which does not
give rise to any income” pursuant to section 1.954-2(e)(3)(ii)
through (iv), Income Tax Regs., and its deemed sale by Dover UK
gave rise to FPHCI taxable to petitioner. Secs. 951(a)(1)(A)(i),
952(a)(2), 954(a)(1), (c)(1)(B)(iii).
Based primarily on the statutory language and legislative
history of section 954(c)(1)(B), respondent also rejects
petitioner’s argument that section 1.954-2(e)(3)(ii) through
(iv), Income Tax Regs., is invalid.
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IV. Motion and Evidentiary Objection
A. Petitioner’s Motion To Strike
1. Introduction
On July 14, 2003, after the parties’ submission of briefs,
pursuant to Rule 52, petitioner moved to strike respondent’s
argument that, as a matter of law, the doctrine of duty of
consistency mandates a finding that Dover UK’s sale of H&C stock
to Thyssen was completed as of June 30, 1997, not July 11, as
urged by petitioner.
2. Duty of Consistency Argument
In its motion, petitioner denies that it is attempting to
“change or recharacterize the facts [regarding the date of the
sale of the H&C stock] in this fully stipulated case” or that it
has “acted in a deceitful or misleading way” as implied by
respondent. Rather, petitioner states that (1) the issue as to
whether the stock sale agreement provided for a June 30 or July
11 sale of the H&C stock presents an issue of law and (2) its
prior representation that the date of sale was June 30, 1997,
constituted “a clear cut mistake of law * * * not a
misrepresentation of fact”. Petitioner also argues that
respondent was not surprised by petitioner’s argument because, on
December 12, 2001, more than a year before it filed its opening
brief, on March 5, 2003, petitioner apprised respondent of its
new position regarding the date of sale. That notification
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consisted of a letter to respondent’s counsel enclosing a copy of
an opinion of U.K. counsel that, under English law, July 11,
1997, was the actual date on which the sale of the H&C stock was
completed.
Respondent objects to petitioner’s motion on the ground that
(1) respondent’s position is nothing more than a legitimate legal
argument and (2) petitioner has not shown that respondent’s
arguments are “redundant, immaterial, impertinent, frivolous, or
scandalous matter” within the meaning of Rule 52.
In essence, petitioner’s motion raises the issue of whether
we should strike respondent’s attack on petitioner’s argument
that the sale of the H&C stock occurred on July 11, 1997, the
date referred to in the stock sale agreement as the “escrow
release date”, rather than on June 30, 1997, the date of that
agreement and the date represented by petitioner to be the date
of sale in the request for 9100 relief. In framing that issue,
the parties have assumed that, were we to find that the stock
sale occurred on July 11, 1997, rather than on June 30, 1997,
there necessarily would be an 11-day period between the deemed
liquidation of H&C into Dover UK and Dover UK’s deemed sale of
the H&C operating assets, during which period Dover UK must be
deemed to have operated the H&C business as its own. Under those
circumstances, petitioner’s assertion that Dover UK’s deemed sale
of the H&C operating assets constituted a sale of property used
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in its (Dover UK’s) business is arguably more persuasive than it
would be if the assets are deemed to have been sold immediately
after the deemed liquidation of H&C.
The underlying assumption by both parties is that, whether
the sale of the H&C stock (and, therefore, the deemed sale of
H&C’s assets) occurred on June 30 or July 11, 1997, the deemed
liquidation of H&C is considered to have occurred immediately
before the close of business on June 29, 1997, the day before the
effective date of H&C’s disregarded entity election, as specified
in the Form 8832 filed by H&C. See sec. 301.7701-3(c)(1)(iii),
(g)(3)(i), Proced. & Admin. Regs. We question that underlying
assumption. In its initial request for 9100 relief, petitioner
specifically requested that “H&C be granted an extension of time
to make * * * [a disregarded entity election] effective
immediately prior to the sale of stock in H&C by Dover UK to
Thyssen UK”. (Emphasis added.) Consistent with petitioner’s
request, respondent granted to H&C, “an [60-day] extension of
time for making [a disregarded entity] election * * * effective
immediately prior to the sale [of H&C stock] on [June 30, 1997]”.
(Emphasis added.) Both petitioner, in filing the Form 8832
listing June 30, 1997, as the effective date of the disregarded
entity election, and respondent, in accepting that filing,
believed that June 30, 1997, was the date of the H&C stock sale
and that the deemed liquidation occurred “immediately prior to”
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that sale. Therefore, although it is not addressed by the
parties, we believe that the parties’ mutual understanding that
the deemed liquidation of H&C was to be “effective immediately
prior to” the sale of the H&C stock raises an issue as to whether
that deemed liquidation should be treated as occurring (1)
“immediately prior to” the sale, whether that sale occurred on
June 30 or July 11, 1997, or (2) regardless of the actual date of
sale, immediately before the close of business on June 29, 1997,
the day before the effective date of the disregarded entity
election, as specified in the Form 8832 filed by H&C. We find it
unnecessary to resolve that issue, however, because, as discussed
infra section V.C., our decision does not depend upon the length
of time between the deemed liquidation of H&C and the actual sale
of its stock (i.e., deemed sale of its assets).
Because resolution of the date-of-sale issue is unnecessary
to our decision in this case, the issue as to whether
respondent’s duty of consistency argument should be stricken is
essentially moot.
3. Conclusion
Petitioner’s motion to strike will be denied.
B. Respondent’s Objection to Stipulated Exhibits
The exhibits to which respondent objects on the grounds of
relevance were all executed in connection with the sale of the
H&C stock to Thyssen. They were introduced by petitioner in
- 23 -
order to show the multiplicity of steps taken and documents
executed between June 30 and July 11, 1997, in order to complete
the sale in accordance with the terms of the June 30, 1997,
agreement. As stated supra section IV.A.2., our decision in this
case does not depend upon the actual date of the H&C stock sale.
As a result, respondent’s evidentiary objection, like
petitioner’s motion to strike respondent’s duty-of-consistency
argument, is essentially moot. Therefore, we shall overrule
respondent’s objection.
V. Status of the H&C Assets as Assets Used in Dover UK’s
Business: Application of Section 1.954-2(e)(3), Income Tax
Regs.
A. Introduction
Petitioner argues that Dover UK’s deemed sale of the H&C
assets qualifies as a sale of property used in Dover UK’s trade
or business. Therefore, pursuant to section 1.954-2(e)(3)(ii)
through (iv), Income Tax Regs., that property is not, within the
meaning of section 954(c)(1)(B)(iii), property “which does not
give rise to any income”, and Dover UK’s sale does not give rise
to FPHCI taxable to petitioner. In support of its argument,
petitioner relies upon the check-the-box regulations and revenue
rulings previously issued by respondent. Respondent disagrees on
the basis of caselaw, which he cites in support of his argument
that Dover UK’s deemed sale of the H&C operating assets did not
constitute a sale of assets “used or held for use” in Dover UK’s
- 24 -
business within the meaning of section 1.954-2(e)(3)(ii) through
(iv), Income Tax Regs.
B. The Relevant Authorities
1. Section 301.7701-2(a), Proced. & Admin. Regs.
Petitioner argues that “the check-the-box regulations * * *
impose continuity of business enterprise as a consequence of * *
* [a disregarded entity] election”, citing section 301.7701-2(a),
Proced. & Admin. Regs. In pertinent part, that regulation
provides: “If * * * [a business entity with only one owner] is
disregarded, its activities are treated in the same manner as a
sole proprietorship, branch or division of the owner.”
Petitioner argues: “As a consequence [of the above-quoted
regulation], there was as a matter of law and under respondent’s
own check-the-box regulations * * * a continuing business use of
H&C’s assets, which were deemed to be a branch or division of
Dover UK.”
2. The Revenue Rulings
Petitioner also argues that respondent’s position in this
case is “wholly inconsistent with” his position contained in
published revenue rulings, which, under principles derived from
the attribute carryover rules of section 381(c) applicable to
section 332 liquidations, “unequivocally attribute the trade or
business of a subsidiary that is liquidated under section 332 to
its parent.” Therefore, because H&C’s disregarded entity
- 25 -
election involved a deemed section 332 liquidation of H&C, see
sec. 301.7701-3(g)(1)(iii) and (2)(ii), Proced. & Admin. Regs.,
petitioner concludes that respondent’s position violates the
principle of Rauenhorst v. Commissioner, 119 T.C. 157, 182-183
(2002), that “taxpayers should be entitled to rely on revenue
rulings in structuring their transactions, and they should not be
faced with the daunting prospect of the Commissioner’s disavowing
his rulings in subsequent litigation”.
The revenue rulings cited by petitioner involve the question
of whether the liquidation of a subsidiary followed by a pro rata
distribution of the proceeds of the sale of the subsidiary’s
assets to the parent’s shareholders in partial redemption of the
parent’s stock may qualify as a partial liquidation of the parent
under former section 346(a)(2).9
The seminal ruling upon which petitioner relies is Rev. Rul.
9
At the time of the issuance of the revenue rulings cited
by petitioner, secs. 331 and 336 governed the tax consequences to
the shareholders and distributing corporation, respectively, of a
partial (or complete) liquidation of the corporation, and sec.
346(a) defined the term “partial liquidation”. Sec. 222 of the
Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L.
97-248, 96 Stat. 478, amended (1) sec. 346 to eliminate the
definition of “partial liquidation” contained therein and (2)
secs. 331 and 336 to omit the reference in each to a partial
liquidation. Sec. 222 of TEFRA also amended (1) sec. 302(e) so
that, essentially, it embodies the former sec. 346(a) definition
of a partial liquidation, and (2) sec. 302(b)(4), so that it
treats a redemption of stock from a non-corporate shareholder in
connection with a partial liquidation of the distributing
corporation as a distribution in part or full payment in exchange
for the stock under sec. 302(a).
- 26 -
75-223, 1975-2 C.B. 109. That ruling describes three situations
in which a parent corporation (P) disposes of a wholly owned
operating subsidiary (S). In situation 1, P liquidates S in a
tax-free section 332 liquidation and sells the S assets for cash.
P distributes the cash to P’s shareholders in redemption of a
portion of their P stock. Situation 2 is the same as situation 1
except that S sells its own assets for cash prior to the section
332 liquidation and subsequent redemption distribution by P. In
situation 3, P simply distributes the S stock pro rata to its
shareholders in redemption of a portion of their P stock. The
issue, as stated in the ruling, is “whether, and to what extent,
the fact that a corporation has conducted a portion of its
business activities through a subsidiary rather than directly
precludes the application of section 346(a)(2) of the Code.”
1975-1 C.B. at 110. Under former section 346, a distribution in
partial redemption of the stock of a corporation is considered to
be made in partial liquidation of the corporation if the
distribution is on account of “the [distributing] corporation’s
ceasing to conduct, or consists of the assets of, a trade or
business * * * [actively conducted throughout the prior 5-year
period and] not acquired by the corporation within such period in
a [taxable] transaction”. Former sec. 346(a) and (b)(1). See
also sec. 1.346-1(a)(2), Income Tax Regs., stating: “An example
of a distribution which will qualify as a partial liquidation
- 27 -
under * * * section 346(a) is a distribution resulting from a
genuine contraction of the corporate business”.
The revenue ruling, after noting that “[t]he business
activities of a subsidiary are not generally considered to be
business activities of its parent corporation”, recognizes that,
under a section 332 liquidation (where the carryover basis rules
of section 334(b)(1) apply), “[s]ection 381, in effect integrates
the past business results of the subsidiary (as represented by
its earnings and profits, net operating loss carryover, etc.)
with those of the parent corporation.” Rev. Rul. 75-223, 1975-1
C.B. at 110. The revenue ruling then states:
For most practical purposes, the parent corporation,
after the liquidation of the subsidiary, is viewed as
if it has always operated the business of the
liquidated subsidiary. Consequently, there is no
meaningful distinction, for purposes of section
346(a)(2), between a corporation that distributes the
assets of a division, or the proceeds of a sale of
those assets, and a parent corporation that distributes
assets of a subsidiary, or the proceeds of a sale of
such assets, received from the subsidiary in a
liquidation governed by sections 332 and 381. [Id.]
Accordingly, the ruling holds that, in situations 1 and 2, “the
fact that the distributions * * * were attributable to assets
that were used by a subsidiary rather than directly by the parent
will not prevent the distribution from qualifying as a ‘genuine
contraction of the corporate business’ of the parent within the
- 28 -
meaning of section 1.346-1(a)(2) of the regulations.” Id.10
In Chief Counsel Memorandum (G.C.M.) 37,054 (Mar. 21,
1977),11 the IRS Chief Counsel described the position taken in
Rev. Rul. 75-223 and in G.C.M. 35,246 (Feb. 20, 1973), in which
the Chief Counsel gave advance approval to the position taken in
Rev. Rul. 75-223, as follows:
Under that Ruling [Rev. Rul. 75-223] and G.C.M. 35246 a
distribution by a parent corporation of the assets of a
subsidiary (or the proceeds of a sale of such assets)
received in a liquidation governed by Code sections 332
and 381 is to be treated no differently than a
distribution by a corporation of the assets of a branch
or division (or the proceeds of a sale of such assets).
10
The ruling contrasts the partial redemption distribution
in situation 3 and treats it as a corporate separation governed
by sec. 355 rather than as a corporate contraction qualifying as
a partial liquidation within the meaning of sec. 346(a)(2). Rev.
Rul. 75-223, 1975-1 C.B. 109, 110. Unlike situations 1 and 2,
situation 3 does not involve a sec. 332 liquidation entailing a
carryover of tax attributes under sec. 381. See also Rev. Rul.
79-184, 1979-1 C.B. 143, involving a parent’s sale of the stock
of its wholly owned subsidiary followed by a distribution (pro
rata) of the sales proceeds to the shareholders of the parent in
partial redemption of their stock. Analogizing the facts of that
ruling to the facts of situation 3 of Rev. Rul. 75-223, Rev. Rul.
79-184, 1979-1 C.B. at 144 holds that “the overall transaction
has the economic significance of the sale of an investment and
distribution of the proceeds” and “does not qualify as a
distribution in partial liquidation within the meaning of section
346(a)(2).”
11
Although under Treasury regulations G.C.M.s do not
establish precedent (see sec. 1.6661-3(b)(2), Income Tax Regs.),
they have been described as “an expression of agency policy”.
Taxation With Representation Fund v. IRS, 646 F.2d 666, 682 (D.C.
Cir. 1981). Moreover, the Court of Appeals for the Second
Circuit (the court to which an appeal of this decision most
likely would lie) has stated that, under certain circumstances,
it may be proper to rely on G.C.M.s for “interpretive guidance”.
Morganbesser v. United States, 984 F.2d 560, 564 (2d Cir. 1993).
- 29 -
Respondent reaffirmed his Rev. Rul. 75-223 position in Rev.
Rul. 77-376, 1977-2 C.B. 107. He also reaffirmed that position
in subsequent private letter rulings.12 See, e.g., Priv. Ltr.
Rul. 2003-01-029 (Jan. 3, 2003), Priv. Ltr. Rul. 2000-04-029
(Jan. 28, 2000), and Priv. Ltr. Rul. 87-04-063 (Oct. 29, 1986),
applying the principles of Rev. Rul. 75-223 in finding partial
liquidation distributions under section 302(b)(4) and (e)(2).
Respondent has also reaffirmed his Rev. Rul. 75-223 position
in the context of transactions other than partial liquidations.
See, e.g., Priv. Ltr. Rul. 80-19-058 (Feb. 13, 1980), involving
an amalgamation of a United States shareholder’s Country X CFCs,
which qualified as a “corporate acquisition” within the meaning
of section 381. Pursuant to the amalgamation, CFC F1 contributed
the stock of its subsidiary, F2, to a new CFC, Newco 1, in
exchange for Newco 1 stock and debentures, the latter
consideration constituting a dividend to F1 under section
356(a)(2). Newco 1 combined with several operating company CFCs,
three of which were same country (Country X) subsidiaries of F1,
to form Newco II. In the private letter ruling, the Commissioner
12
Private letter rulings may be cited to show the practice
of the Commissioner. See Rowan Cos. v. United States, 452 U.S.
247, 261 n.17 (1981); Hanover Bank v. Commissioner, 369 U.S. 672,
686-687 (1962); Rauenhorst v. Commissioner, 119 T.C. 157, 170 n.8
(2002); Estate of Cristofani v. Commissioner, 97 T.C. 74, 84 n.5
(1991); Woods Inv. Co. v. Commissioner, 85 T.C. 274, 281 n.15
(1985).
- 30 -
states that “a surviving corporation carries with it all those
characteristics which the merged corporation had prior to the
merger * * * [including] the attribute of a predecessor
corporation having engaged in a trade or business with respect to
the use of its assets”, even though that is not an item
specifically listed in section 381(c) as carrying over to the
surviving corporation. Accordingly, the IRS ruled that the
amounts treated as section 356(a)(2) dividends paid to F1 out of
the earnings and profits of a party to the Newco II amalgamation
which were accumulated when that party (1) was a related person
to F1 within the meaning of section 954(d)(3), (2) had been
created or organized under the same foreign country laws as F1,
and (3) had a “substantial part” of the assets used in its trade
or business located in such foreign country would not be
includable in FPHCI of F1 for purposes of section 954, by reason
of section 954(c)(4)(A) (now section 954(c)(3)(A)(i)), the so-
called same country exception to the treatment, as FPHCI, of
related party dividends or interest. In other words, the IRS
found that Newco II inherited from former operating subsidiaries
of F1 collapsed into it in a transaction subject to section 381
the attribute of being “engaged in a trade or business with
respect to the use of * * * [those subsidiaries’] assets”.
Therefore, a portion of the Newco II dividend to F1 arising out
of F1's receipt of the Newco I debentures (which become Newco II
- 31 -
debentures) was excluded from FPHCI by the same country
exception.
3. The Caselaw
Respondent relies principally upon four cases in support of
his argument that the H&C assets were not used in Dover UK’s
business before their deemed sale by Dover UK: Reese v.
Commissioner, 615 F.2d 226 (5th Cir. 1980), affg. T.C. Memo.
1976-275; Azar Nut Co. v. Commissioner, 94 T.C. 455 (1990), affd.
931 F.2d 314 (5th Cir. 1991); Acro Manufacturing Co. v.
Commissioner, 39 T.C. 377 (1962), affd. 334 F.2d 40 (6th Cir.
1964); and Ouderkirk v. Commissioner, T.C. Memo. 1977-120. In
three of those cases (Reese, Azar Nut, and Ouderkirk) the issue
is whether an individual’s gain or loss on the sale of a parcel
of real property is capital or ordinary.
a. Reese v. Commissioner
In Reese, the taxpayer financed the construction of a
manufacturing plant, which he intended to sell to investors who
would agree to lease the building to a corporation for use in the
corporation’s manufacturing business. The taxpayer was the chief
officer and principal shareholder of the corporation. The
partially completed plant was sold at a loss to satisfy a
judgment against the taxpayer. The issue was whether the loss
was capital or ordinary. The taxpayer argued for ordinary loss
treatment on the ground that the plant was either (1) held
primarily for sale to customers in the ordinary course of his
- 32 -
construction business or (2) used in a trade or business,
excludable, in either case, from capital asset status under what,
respectively, are now paragraphs (1) and (2) of section 1221(a).
The Court of Appeals for the Fifth Circuit found that (1) the
taxpayer’s activities in financing and acting as builder,
developer, and general contractor for the construction of the
plant between 1968 and 1970, when the building was sold,
constituted “an isolated, non-recurring venture”, which did not
constitute a trade or business, and (2) the property sold was
intended for use by the corporation in its manufacturing
business, not by the taxpayer in his business of being a
corporate executive. Reese v. Commissioner, 615 F.2d at 231.
Therefore, the Court of Appeals held that the property was not
excluded from the definition of a capital asset as either
property held for sale to customers in the ordinary course of
business or as property used in the taxpayer’s trade or business.
Id.
In support of his argument that Dover UK’s deemed holding of
the H&C operating assets “for only a moment before the sale” did
not transform those assets into assets used in Dover UK’s
business, respondent relies on the conclusion of the Court of
Appeals in Reese that an “isolated, non-recurring venture” cannot
amount to the conduct of a trade or business. The facts before
the Court of Appeals, and the question it answered, however, are
- 33 -
distinguishable from the facts and question before us. In Reese,
the Court of Appeals was asked to conclude (and did conclude)
that the taxpayer’s venture into real property construction never
amounted to the conduct of a trade or business. Here, on the
deemed liquidation of H&C, Dover UK is deemed to have received
the assets of what undeniably was an ongoing business. The
question is whether that business was ever conducted by Dover UK.
Reese does not answer that question.13
b. Ouderkirk v. Commissioner and Azar Nut Co.
v. Commissioner
Ouderkirk v. Commissioner, T.C. Memo. 1977-120, involved an
individual who, in connection with the liquidation of a
corporation, received 7,700 acres of cut-over timberland and an
obsolete and inefficient sawmill, both of which the taxpayer
contributed to a partnership owned by him and his wife. After
refurbishment, the sawmill was placed in operation. Over an 11-
year period, approximately 80 percent of the timber processed by
the sawmill was acquired from sources outside the 7,700 acres of
timberland owned by the partnership. At the end of that period,
the partnership sold the sawmill at a loss (which it reported,
13
The position of the Court of Appeals for the Fifth
Circuit in Reese v. Commissioner, 615 F.2d 226 (5th Cir. 1980),
affg. T.C. Memo. 1976-275, that a single nonrecurring venture
ordinarily will not be considered a trade or business, has been
referred to as the “one-bite” rule, a rule that has been
specifically rejected by this Court. See Cottle v. Commissioner,
89 T.C. 467, 488 (1987); Morley v. Commissioner, 87 T.C. 1206,
1211 (1986); S&H, Inc. v. Commissioner, 78 T.C. 234, 244 (1982).
- 34 -
and passed through to the taxpayer and his wife, as an ordinary
loss from the sale of property used in a trade or business) and
sold the timberland at a gain (which it reported, and passed
through to the taxpayer and his wife, as a capital gain from the
sale of an investment asset). The Commissioner challenged the
characterization of the timberland gain as capital gain, arguing
that the timberland was not a capital asset because it was
property used in the partnership’s sawmill and lumber business.
We rejected the Commissioner’s position and sustained the
taxpayer’s argument that the property was investment property in
the hands of the partnership. In reaching that conclusion, we
noted that “[t]he incidental use of this 7,700-acre tract in
connection with * * * [the] cutting of scattered timber did not
convert the tract from investment property to real property used
in the [partnership’s] sawmill business within the meaning of
section 1231.” Id.
In Ouderkirk, as in Reese v. Commissioner, supra, the issue
was whether the property in question had a business connection
sufficient to require its exclusion from the definition of a
capital asset (in Ouderkirk, as property used in a trade or
business, and, in Reese, as inventory type property). Therefore,
Ouderkirk, like Reese, is distinguishable from this case, where
the issue is whether assets undeniably used in a trade or
business were used in a trade or business conducted by Dover UK.
- 35 -
In Azar Nut Co. v. Commissioner, 94 T.C. 455 (1990), the
taxpayer, in connection with its termination of an individual’s
employment, purchased the employee’s residence at an appraised
fair market value pursuant to the terms of an employment
agreement. The taxpayer immediately listed the house for sale at
the purchase price paid to its former employee but eventually
incurred a substantial loss on the sale, some 22 months later.
Because the house was never held for rental by the taxpayer or
used or intended for use in the taxpayer’s business, we held that
it was not exempt from capital asset status as property used in a
trade or business and that the loss was, therefore, capital
loss.14 Id. at 463-464. In Azar Nut, as in Ouderkirk v.
Commissioner, supra, and Reese v. Commissioner, supra, capital
asset status was based upon insufficient (or no) business use,
not, as respondent argues in this case, upon the identity of the
user of assets undeniably used in a trade or business.
14
The taxpayer in Azar Nut Co. v. Commissioner, 94 T.C.
455 (1990), affd. 931 F.2d 314 (5th Cir. 1991), argued that the
house was not a capital asset because its purchase from the
terminated employee and subsequent resale were connected with the
taxpayer’s business; i.e., the transactions arose out of a
business necessity, not an investment purpose. We rejected that
argument on the basis of Ark. Best Corp. v. Commissioner, 485
U.S. 212 (1988). That case rejected the business connection-
business motivation rationale of such cases as Commissioner v.
Bagley & Sewall Co., 221 F.2d 944 (2d Cir. 1955)(relied upon by
the taxpayer in Azar Nut), affg. 20 T.C. 983 (1953), and held
that property constitutes a capital asset unless it is excluded
from capital asset status by one of the specific statutory
exclusions listed in what is now sec. 1221(a). Ark. Best Corp.
v. Commissioner, supra at 223.
- 36 -
c. Acro Manufacturing Co. v. Commissioner
In Acro Manufacturing Co. v. Commissioner, 39 T.C. 377
(1962), the taxpayer, a manufacturer of precision switches and
thermostatic controls, acquired in a tax-free reorganization the
stock of Universal Button Company (Button), a manufacturer of
metal buttons for work clothes. Some 3 months later, the
taxpayer received an offer to buy all of the stock or assets of
Button. Because the taxpayer wished to avoid capital loss on a
sale of the Button stock, the parties to the transaction
negotiated an agreement for the sale of Button’s assets whereby
the taxpayer would liquidate Button and sell its assets to the
purchaser. Pursuant to that agreement, Button adopted a plan of
complete liquidation. On the following day, less than 7 months
after its acquisition by the taxpayer, Button underwent a tax-
free section 332 liquidation, and its assets were sold by the
taxpayer to the purchaser for cash plus the purchaser’s
assumption of the liabilities relating to the business formerly
carried on by Button. Button’s business continued uninterrupted
during the foregoing ownership transfers.
The taxpayer argued that the non-capital asset character of
the assets in Button’s hands should carry over to the taxpayer
after the section 332 liquidation because, under the section
1223(2) holding period “tacking” provisions, the taxpayer is
- 37 -
deemed to have held or owned those assets while they were used by
Button in the conduct of its business. Acro Manufacturing Co. v.
Commissioner, supra at 383. Respondent, while admitting that the
assets distributed to the taxpayer in connection with the section
332 liquidation of Button were not capital assets in Button’s
hands, argued that, because the former Button assets were never
used in the taxpayer’s business, they constituted capital assets
in the taxpayer’s hands. Id. at 384.
We rejected the taxpayer’s arguments and held that the
character of the Button assets did not automatically carry over
to the taxpayer; rather, we stated that our concern was with the
“tax nature” of those assets in the taxpayer’s hands. We asked:
“Were the assets acquired or used in connection with a business
of * * * [the taxpayer]?” Id. We found that the taxpayer
“neither acquired nor used the Button assets in its business,
neither did * * * [the taxpayer] enter into the button business.”
Id. at 386. In connection with those findings, we rejected the
taxpayer’s argument that it used the former button assets in its
business “for a short time”, between the same-day liquidation of
Button and sale of its assets, stating that “ownership for such a
minimal, transitory period is insufficient to establish ‘use’ of
the distributed assets in * * * [the taxpayer’s] business or to
place * * * [the taxpayer] in the button business.” Id. at 384.
As a result, we found that the former Button assets were capital
- 38 -
assets in the taxpayer’s hands and the taxpayer’s sale of those
assets resulted in a capital loss. Id. at 386.
Both the result in Acro Manufacturing Co. v. Commissioner,
supra, and our reasoning in reaching that result were affirmed by
the Court of Appeals for the Sixth Circuit. Acro Manufacturing
Co. v. Commissioner, 334 F.2d 40 (6th Cir. 1964). In affirming
our decision that the taxpayer’s “minimal, transitory” period of
actual ownership of assets whose character was non-capital in
Button’s hands was insufficient to establish their character as
non-capital assets in the taxpayer’s hands, the Court of Appeals
observed that it was “not advised of any showing by the
taxpayer’s corporate records” that the taxpayer did, in fact,
operate the button business for any period of time. Id. at 44.15
While the facts of Acro Manufacturing Co. v. Commissioner,
39 T.C. 377 (1962), involve an actual, rather than a deemed,
section 332 liquidation, we do not believe that that is a
consequential difference. Because the period between the deemed
distribution in liquidation of H&C’s assets and the deemed sale
of those assets can be described as a “minimal, transitory
15
Respondent points out that Dover UK failed to report any
income from H&C’s business on its 1997 return filed with the
United Kingdom Inland Revenue. While we deem that fact
irrelevant, we note that Dover UK’s United Kingdom tax reporting
position is justified by the fact that H&C’s disregarded entity
election resulted in a deemed liquidation of H&C effective for
United States, but not United Kingdom, tax purposes.
- 39 -
period”, we conclude that the facts before us are, as pertinent,
not distinguishable from the facts in Acro Manufacturing Co.
C. Analysis and Application of Authorities
Respondent specifically acknowledges that, for tax purposes,
H&C’s disregarded entity election constituted a deemed section
332 liquidation of H&C into Dover UK, whereby H&C became a branch
or division of Dover UK. Respondent refers to the disregarded
entity election as a “check-the-box liquidation” and states that
there is no difference between it and an actual section 332
liquidation.
Accordingly, the principal question before us is whether,
attendant to a section 332 liquidation, the transferee parent
corporation succeeds to the business history of its liquidated
subsidiary with the result that the subsidiary’s assets used in
its trade or business constitute assets used in the parent’s
trade or business upon receipt of those assets by the parent.
Because Dover UK’s disregarded entity election is
characterized as an actual liquidation of H&C for income tax
purposes, among the undisputed tax consequences are the
following: (1) Dover UK recognized neither gain nor loss on its
deemed receipt of H&C’s assets, see sec. 332(a); (2) it succeeded
to H&C’s basis in those assets, see sec. 334(b); and (3) it would
add H&C’s holding period to its own (deemed) holding period in
those assets, see sec. 1223(2). Moreover, the deemed-received
assets did not constitute a single, mass asset with a unitary
- 40 -
holding period, but comprised the numerous classes of both
tangible and intangible property necessary to constitute a going
elevator installation and service business (e.g., tools, spare
parts, fixtures, and accounts receivable). Each item deemed
received by Dover UK came with a distinct, carryover basis and an
existing holding period. Cf. Williams v. McGowan, 152 F.2d 570,
572 (2d Cir. 1945) (capital asset status of the assets of a
business sold shortly after the partnership conducting the
business was terminated must be determined on an asset by asset
basis).
Agreeing, as he must, to the foregoing description of the
tax consequences resulting to Dover UK from its deemed receipt of
H&C’s assets, respondent, nevertheless, argues: “Dover UK must *
* * use, or hold for use, such assets for the requisite period of
time in its trade or business before Dover UK is allowed to
exclude from FPHCI the gain from the [deemed] sale of those
assets.” Respondent refuses to attribute H&C’s business history
to Dover UK:
Dover UK had a separate identity from H&C and the
business of H&C (installing and servicing elevators)
was not the business of Dover UK (a holding company).
In addition, Dover UK never intended to use the assets
in an elevator business. It acquired the assets for
the purpose of selling those assets and avoiding FPHCI.
The arguments of the parties concerning whether we must deem
Dover UK to have succeeded to H&C’s business history center on
section 381, which provides that the acquiring corporation in a
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section 332 liquidation succeeds to the various tax attributes of
the distributing corporation described in section 381(c).16
While section 381(c) does not list among the carryover attributes
the distributing corporation’s business history, we agree with
petitioner that respondent’s denial that Dover UK succeeded to
H&C’s business history is inconsistent with his position in Rev.
Rul. 75-223, 1975-1 C.B. 109, Rev. Rul. 77-376, 1977-2 C.B. 107,
G.C.M. 37,054 (Mar. 21, 1977), and a number of private letter
rulings (discussed supra section V.B.). Respondent argues that
the conclusion reached in Rev. Rul. 75-223 (and reaffirmed in
subsequent published and private rulings) should be limited to
section 346. Respondent further states that “petitioner should
not be allowed to argue that the tax attributes of a subsidiary
are carried over to the parent in all cases under * * * [section
381].” We disagree.
The crucial finding in all of the rulings discussed supra
section V.B., is that, in any corporate amalgamation involving
the attribute carryover rules of section 381, the surviving or
recipient corporation is viewed as if it had always conducted the
business of the formerly separate corporation(s) whose assets are
16
Among the tax attributes of the transferor subsidiary
that carry over to the transferee parent, pursuant to sec.
381(c), are net operating loss and capital loss carryovers,
earnings and profits, and the subsidiary’s overall method of
accounting, method of computing inventories, and method of
computing the allowance for depreciation.
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acquired by the surviving corporation. See, e.g., Rev. Rul. 75-
223, 1975-1 C.B. at 110. The Chief Counsel has stated
unequivocally that the impact of that finding on a distribution
by a corporation of assets received by it in a section 332
liquidation is that the distribution “is to be treated no
differently than a distribution by a corporation of the assets of
a branch or division”. G.C.M. 37,054 (Mar. 21, 1977). Although
that principle has been applied by the Commissioner in specific
contexts (generally, in connection with former section 346 or
section 302(e) partial liquidations), it has been stated as a
principle of law applicable in any case involving a corporate
combination to which section 381 applies. That includes a
section 332 liquidation. Moreover, if a parent corporation’s
distribution to its shareholders of the operating assets of a
former subsidiary, immediately after receiving those assets in a
section 332 liquidation of the subsidiary, qualifies as “a
genuine contraction of the * * * [parent corporation’s] business”
for purposes of section 1.346-1(a)(2), Income Tax Regs., we fail
to see any basis for not applying the same rationale to the
parent’s sale of the liquidated subsidiary’s assets, so that the
sale is treated as a sale of assets used in the parent
corporation’s business for purposes of section 1.954-2(e)(3)(ii)
through (iv), Income Tax Regs.
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In Rauenhorst v. Commissioner, 119 T.C. 157 (2002), we
refused “to allow * * * [IRS] counsel to argue the legal
principles of * * * opinions against the principles and public
guidance articulated in the Commissioner’s currently outstanding
revenue rulings.” Id. at 170-171. Consistent with our holding
in Rauenhorst, we refuse to allow respondent to argue the legal
principles of Acro Manufacturing Co. v. Commissioner, 39 T.C. 377
(1962), against the principles subsequently articulated in Rev.
Rul. 75-223, 1975-2 C.B. 109, Rev. Rul. 77-376, 1977-2 C.B. 107,
and G.C.M. 37,054 (Mar. 21, 1977). We therefore consider
respondent to have conceded that, as a direct result of a section
332 liquidation of an operating subsidiary, the surviving parent
corporation is considered as having been engaged in the
liquidated subsidiary’s preliquidation trade or business, with
the result that the assets of that trade or business are deemed
assets used in the surviving parent’s trade or business at the
time of receipt. See Rauenhorst v. Commissioner, supra at 170-
171, 173. As stated by respondent on brief, pursuant to section
301.7701-3(g)(1)(ii) and (2)(i), Proced. & Admin. Regs., “there
is no difference between a check-the-box liquidation and an
actual liquidation.” Therefore, notwithstanding our holding in
Acro Manufacturing Co. v. Commissioner, supra,17 we conclude that
17
We need not revisit our decision in that case at this
time.
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respondent has conceded that Dover UK’s deemed sale of the H&C
assets immediately after the check-the-box liquidation of H&C
constituted a sale of property used in Dover UK’s business within
the meaning of section 1.954-2(e)(3)(ii) through (iv), Income Tax
Regs.18 That result is consistent with the conclusion of the
Court of Appeals for the Second Circuit in Williams v. McGowan,
152 F.2d 570 (2d Cir. 1945), that depreciable property and
inventory that had been part of a business sold shortly after the
partnership conducting the business was terminated retain their
status as non-capital assets in the hands of the individual
seller.
Respondent’s acknowledgment that the business history and
activities of a subsidiary carry over to its parent in connection
with a section 332 liquidation of the subsidiary is also
reflected in section 301.7701-2(a), Proced. & Admin. Regs., which
provides that “if the entity is disregarded, its activities are
treated in the same manner as a sole proprietorship, branch, or
division of the owner”. In the context of a business
organization, a “branch” is defined as a “division of a
business”, and a “division” as an “area of * * * corporate
18
Because H&C’s use of its assets was entirely business
related, that use almost certainly covered more than one-half of
the various periods that, taking into account sec. 1223(2), Dover
UK is deemed to have held those assets. Therefore, that use is
deemed to be the use for which those assets were held for
purposes of sec. 1.954-2(a)(3), Income Tax Regs.
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activity organized as an administrative or functional unit.”
American Heritage Dictionary (4th ed. 2000); see also Black’s Law
Dictionary 188, 479 (6th ed. 1990) (defining a “branch”, in
relevant part, as a “[d]ivision, office, or other unit of
business located at a different location from main office or
headquarters”, and a “division” as an “[o]perating or
administrative unit of * * * business”). Thus, the plainly
understood import of the cited regulation’s use of the terms
“branch” and “division” to describe the impact of the deemed
section 332 liquidation resulting from a disregarded entity
election with respect to an operating subsidiary (particularly in
light of respondent’s ruling position, as set forth supra) is
that the activities of the business operation indirectly owned by
the parent through its former subsidiary become the activities of
a functional or operating business unit directly owned and
conducted by the parent.19 It follows from the language of the
regulation that the assets used in the business of the (deemed)
liquidated subsidiary retain their status as assets used in the
19
Sec. 301.7701-2(a), Proced. & Admin. Regs., does not
specify a minimum period of time after which a disregarded entity
election results in branch or division status for the disregarded
entity. Rather, the disregarded entity is deemed a branch or
division of the owner upon the effective date of the election, a
point that is conceded by respondent on brief. Nor do the check-
the-box regulations require that the taxpayer have a business
purpose for such an election or, indeed, for any election under
those regulations. Such elections are specifically authorized
“for federal tax purposes”. Sec. 301.7701-3(a), Proced. & Admin.
Regs.
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same business by the (deemed) branch or division of the parent.
We interpret our statement in Acro Manufacturing Co. v.
Commissioner, 39 T.C. 386, that the taxpayer “neither acquired
nor used the Button assets in its business” as tantamount to a
statement that the Button business never became an operating
branch or division of the taxpayer. Therefore, the Secretary and
the Commissioner, in effect, rejected our position in that case
by issuing section 301.7701-2(a), Proced. & Admin. Regs., as well
as Rev. Rul. 75-223, Rev. Rul. 77-376, and G.C.M. 37,054.20
Finally, we note that, consistent with his admonition in the
preamble to the final check-the-box regulations, T.D. 8697, 1997-
1 C.B. at 216, that “Treasury and the IRS will continue to
monitor carefully the uses of partnerships [and, by extension,
disregarded entities] in the international context and will take
appropriate action when * * * [such entities] are used to achieve
results that are inconsistent with the policies and rules of
20
Because of Rev. Rul. 75-223, 1975-2 C.B. 109, and its
progeny, petitioner’s interpretation of sec. 301.7701-2(a),
Proced. & Admin. Regs., as requiring the post-(deemed)
liquidation business activities of H&C to be considered business
activities of Dover UK immediately following the deemed
liquidation of H&C is certainly a plausible interpretation of
that regulation. As we stated in Corn Belt Hatcheries of Ark.,
Inc. v. Commissioner, 52 T.C. 636, 639 (1969), in sustaining the
taxpayer’s plausible interpretation of an ambiguous ruling,
“[t]axpayers are already burdened with an incredibly long and
complicated tax law. We see no reason to add to this burden by
requiring them anticipatorily to interpret ambiguities in
respondent’s rulings to conform to his subsequent
clarifications”.
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particular Code provisions”, respondent was, of course, free to
amend his regulations to require a minimum period of continuous
operation of a foreign disregarded entity’s business, prior to
the disposition of that business, as a condition precedent to
treating the owner as having been engaged in the trade or
business for purposes of characterizing the gain or loss. But,
in the absence of respondent’s exercise of that authority, we
must apply the regulation as written. See Exxon Corp. v. United
States, 88 F.3d 968, 974-975 (Fed. Cir. 1996); Woods Inv. Co. v.
Commissioner, 85 T.C. 274, 282 (1985); Henry C. Beck Builders,
Inc. v. Commissioner, 41 T.C. 616, 628 (1964). As we observed in
sustaining the application of a provision of the consolidated
return regulations, the fact that the regulation gives rise to a
perceived abuse is “a problem of respondent’s own making”, a
problem that respondent has allowed to persist by choosing “not
to amend the regulations to correct the problem.” CSI
Hydrostatic Testers, Inc. v. Commissioner, 103 T.C. 398, 411
(1994), affd. 62 F.3d 136 (5th Cir. 1995).21
21
Respondent did include an allegedly corrective amendment
as part of proposed regulations issued on Nov. 29, 1999. See
REG-110385-99, 64 Fed. Reg. 66591 (Nov. 29, 1999). The proposed
regulations contained a special rule for foreign disregarded
entities used in a so-called extraordinary transaction, one of
which constitutes the sale of a 10-percent or greater interest in
such an entity within 12 months of the entity’s change in
classification from association taxable as a corporation to
disregarded entity. Under those circumstances, the proposed
regulations provided that the disregarded entity “will instead be
(continued...)
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VI. Validity of Section 1.954-2(e)(3), Income Tax Regs.
Because we find that Dover UK’s deemed sale of the H&C
assets constituted a sale of assets used in Dover UK’s business
within the meaning of section 1.954-2(e)(3)(ii) through (iv),
Income Tax Regs., we do not address petitioner’s argument that
section 1.954-2(e)(3), Income Tax Regs., is invalid.
VII. Conclusion
Dover UK’s gain on the deemed sale of the H&C assets does
not constitute FPHCI to petitioner pursuant to section
954(c)(1)(B)(iii).
Decision will be entered
under Rule 155.
21
(...continued)
classified as an association taxable as a corporation”. Sec.
301.7701-3(h)(1), Proposed Proced. & Admin. Regs., 64 Fed. Reg.
66594 (Nov. 29, 1999). (We assume that the consequence of that
approach would be that a CFC’s sale of the stock of the
disregarded entity would be treated as a sale of property
described in sec. 954(c)(1)(B)(i), rather than as a sale of
property described in sec. 954(c)(1)(B)(iii), which is
respondent’s approach in this case, under the existing
regulations.) After receiving a number of unfavorable comments,
respondent, on June 26, 2003, issued Notice 2003-46, 2003-28
I.R.B. 53, announcing his intention to withdraw the so-called
extraordinary transaction rule of the proposed regulations.
Formal withdrawal of that portion of the proposed regulations
occurred on Oct. 22, 2003. See REG-1110385-99, 68 Fed. Reg.
60305 (Oct. 22, 2003).