Trinova Corp. v. Commissioner , 108 T.C. 68 ( 1997 )

SWIFT, J.,

respectfully dissenting: With the benefit of the analyses provided in the opinions of the Second and Ninth Circuit Courts of Appeals in Salomon, Inc. v. United States, 976 F.2d 837 (2d Cir. 1992), and Walt Disney Inc. v. Commissioner, 4 F.3d 735 (9th Cir. 1993), we should recognize the error made in our opinion in Walt Disney Inc. v. Commissioner, 97 T.C. 221 (1991), and sustain respondent’s position in this case.

The majority suggests that the issue herein turns primarily on whether a particular provision of the consolidated return regulations (namely, sec. 1.1502-3(f)(3), Example (5), Income Tax Regs.) controls over a revenue ruling (namely, Rev. Rui. 82-20, 1982-1 C.B. 6). The majority argues that the above Courts of Appeals, in the cited opinions, give undue weight to the revenue ruling and ignore what the majority regards as the clear mandate of the regulation under section 1502.

The majority is correct in stating that revenue rulings do not generally constitute legal precedent or “other law”. As the language quoted below, however, from each of the cited opinions indicates, the U.S. Court of Appeals for neither the Second nor the Ninth Circuit relies exclusively on the conclusive effect of the revenue ruling. Rather, both rely heavily on “economic reality” and the “substance-over-form” doctrines, which are simply broader labels for, and which encompass, the step transaction doctrine.

The Court of Appeals for the Second Circuit in Salomon, Inc. v. United States, supra at 842-843, explained as follows:

In substance, if not in form, the direct and the circuitous transaction are the same. See Commissioner v. Court Holding Co., 324 U.S. 331, 334, 65 S.Ct. 707, 708, 89 L.Ed. 981 (1945). Each achieves a rapid transfer of section 38 property outside the group. To distinguish between them would deny economic reality. See Gregory v. Helvering, 293 U.S. 465, 470, 55 S.Ct. 266, 268, 79 L.Ed. 596 (1935) (refusing to “exalt artifice above reality” in determining tax liability). Moreover, such a holding would allow the common parent of a consolidated group, such as * * * [the parent], to move section 38 property outside the group without paying recapture taxes simply by first transferring the property to a member subsidiary and then distributing the subsidiary’s stock to the third-party. * * *

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The rapidity with which these components follow one another suggest that they are, in substance, parts of one overall transaction intended to dispose of the section 38 assets outside of the consolidated group. * * * These factual circumstances, timing and intent ***.*** jea¿ ^g conclusion that the two components are steps in a larger transaction which, when viewed as a whole, constitutes a section 47(a)(1) “disposition.” * * *

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Under these circumstances, the transaction is, in substance, a means of moving the assets outside the group. * * *

The Court of Appeals for the Ninth Circuit in Walt Disney Inc. v. Commissioner, supra at 741, relied heavily upon the analysis of the Court of Appeals for the Second Circuit, quoted from the above language, and stated the following—

“in substance, if not in form, the direct and the circuitous transaction are the same” and “to distinguish between them would deny economic reality” and would allow the common parent of a consolidated group to circumvent easily the recapture requirement. * * *

The position we adopted in our opinion in Walt Disney Inc. v. Commissioner, 97 T.C. at 221, failed to apply properly the substance-over-form doctrine and failed to give proper weight to section 1.47 — 3(f)(1), Income Tax Regs., which provides clearly that to the extent ownership of an affiliated transferee corporation changes hands as part of the transfer of property to the transferee corporation, a taxable disposition has occurred under section 47. See sec. 1.47 — 3(f)(1), (2), (6), Examples (2), (3), and (4), Income Tax Regs.

The above regulations, section 1.47-3(f)(1), (2), and (6), Income Tax Regs., should be read together with section 1.1502 — 3(f)(3), Income Tax Regs. Where a change in ownership of an affiliated transferee company is contemplated at the time of a transfer of section 38 property and where the change in ownership that occurs is, in substance, in economic reality, and/or under the step transaction doctrine, integral to the transfer of the property outside the affiliated group, the transfer should be treated, to the extent of the change in ownership of the transferee corporation, as a taxable disposition under section 47.

The weight to be given a revenue ruling is not the issue in this case. Rather, the issue is the validity of the underlying rationale of Rev. Rui. 82-20, 1982-1 C.B. 6, — namely, whether the transaction before us and its taxability under section 47 is controlled by the substance thereof. As is explained in the cited ruling:

When there is no intention at the time of transfer to keep the property within the consolidated group, the transaction should be viewed as a whole and not as separate individual transactions. * * *

Because the transfer * * * is a step in the planned transfer of the property outside the group, section 1.1502 — 3(f)(2)(i) of the regulations does not apply. [Rev. Rui. 82-20, 1982-1 C.B. 6; citations omitted.]

In Tandy Corp. v. Commissioner, 92 T.C. 1165 (1989), we held that, on the particular facts of that case, recapture under section 47 was not appropriate where a change in ownership of a transferee corporation occurred in a year after a transfer of property to the transferee corporation. With respect, however, to a fact situation similar to the instant case (where a transfer of property and an ownership change in the transferee corporation effectively occur during the same taxable year and as part of the same integral transaction), we explained in Tandy Corp. v. Commissioner, supra at 1171, that section 47 recapture would be triggered, as follows:

To treat * * * [the taxpayer] as having relinquished during the year before the Court a “substantial interest” as contemplated by section 1.47-3(f)(l)(ii)(b), Income Tax Regs., would require a concomitant finding that such an interest passed to * * * [the taxpayer’s] shareholders at the same time. * * *

The majority op. p. 77 implicitly acknowledges that the substance-over-form and step transaction doctrines have application as “other law” in the consolidated return context under section 1.1502-80, Income Tax Regs. The majority, however, summarily dismisses the application of such doctrines to the specific facts of this case because each step of the reorganization plan adopted by petitioner had a business purpose.

Both the Second and the Ninth Circuit Courts of Appeals in the above-cited opinions applied the substance-over-form doctrine in spite of the presence of a business purpose for each step of the reorganizations involved in those cases and, as stated above, concluded that the substance thereof, for purposes of section 47, constituted dispositions of property outside the consolidated group, thus triggering recapture under section 47. See also the District Court’s opinion in Salomon, Inc. v. United States, 92-1 USTC par. 50,155 (S.D.N.Y. 1992).

In King Enters., Inc. v. United States, 189 Ct. Cl. 466, 418 F.2d 511, 516 n.6 (1969), the Court of Claims explained that various courts have—

enunciated a variety of doctrines, such as step transaction, business purpose, and substance over form. Although the various doctrines overlap and it is not always clear in a particular case which one is most appropriate, their common premise is that the substantive realities of a transaction determine its tax consequences.

With regard more specifically to the question of the relationship between the step transaction doctrine and the business purpose aspect of a transaction and in the context of analyzing a section 332 liquidation, the Court of Appeals for the Tenth Circuit in Associated Wholesale Grocers, Inc. v. United States, 927 F.2d 1517 (10th Cir. 1991), rejected the contention that a valid business purpose precludes application of the step transaction doctrine. The Court of Appeals explained as follows:

Most cases applying the step transaction doctrine, far from identifying business purpose as an element whose absence is prerequisite to that application, do not even include discussion of business purpose as a related issue. In some cases, the existence of a business purpose is considered one factor in determining whether form and substance coincide. In others, the lack of business purpose is accepted as reason to apply the step transaction doctrine. We have found no case holding that the existence of a business purpose precludes the application of the step transaction doctrine. [Associated Wholesale Grocers, Inc. v. United States, 927 F.2d at 1526-1527; fn. refs, omitted.]

The Court of Appeals for the Tenth Circuit in Associated Wholesale Grocers, Inc. v. United States, supra at 1527 n.15, also cited our opinion in Vest v. Commissioner, 57 T.C. 128 (1971), affd. in part on other grounds and revd. in part 481 F.2d 238 (5th Cir. 1973), and commented thereon as follows:

After identifying a business purpose, the * * * [Tax Court in Vest v. Commissioner] undertakes a thorough discussion of whether to treat a stock exchange as a step transaction. 57 T.C. at 145. The * * * [Tax Court] remarked “[t]he fact that there were business purposes for the incorporation of V Bar is an indication that its formation was not a step mutually interdependent with the subsequent stock exchange” and continued to consider other factors, including the existence of a binding commitment, the timing of the steps, and the actual intent of parties. Id. at 145-46. (Emphasis added [by Tenth Circuit].) Far from precluding step transaction analysis, the business purpose was not even considered the most significant factor in Vest. * * *

In Yoc Heating Corp. v. Commissioner, 61 T.C. 168, 177 (1973) (Court reviewed), we expressly commented on the relationship between the step transaction doctrine and the business purpose aspect of a transaction, and we did so in the particular context of the reorganization provisions of the Code, which were also involved in that case, as follows:

Our path to decision is framed within two cardinal principles, which apply in the reorganization area and which are so well established as not to require supporting citations. First, the fact that the form of the transaction conforms to the literal wording of the definition of a reorganization is not controlling. Second, when a transaction is composed of a series of interdependent steps, each undertaken to achieve an overall objective, the various steps should be viewed in their entirety for the purpose of determining its tax consequences — the so-called “integrated transaction” doctrine. * * * The fact that for valid business reasons there was a delay of several months before * * * [the new entity] came into existence and completed the acquisition does not militate against * * * [application of the step transaction doctrine], [Citations omitted.]

It is acknowledged that the Commissioner in Rev. Rul. 79-250, 1979-2 C.B. 156, suggested that, in the context of certain reorganization transactions, preliminary and related transactions or steps will not necessarily be stepped together and ignored where each such preliminary step constitutes a permanent alteration of a previous bona fide business relationship. That general statement in Rev. Rul. 79-250, supra, however, does not preclude application of the step transaction doctrine, the substance over form doctrine, or the integrated transaction doctrine to the facts of this case involving recapture of investment tax credit under section 47. See also Associated Wholesale Grocers, Inc. v. United States, supra at 1526-1527; Rev. Rul. 96-29, 1996-1 C.B. 50.

Based on the above authority, I believe that the majority herein errs in suggesting, majority op. p. 78, that the business purpose associated with the transfer of petitioner’s glass division to a subsidiary and with the change in ownership of the subsidiary provides, for purposes of section 47 recapture, the sum and substance of the transaction before us and effectively precludes any meaningful analysis under the substance-over-form, the step transaction, or the integrated transaction doctrine.

A brief analysis of the substance and steps of the transactions before us is appropriate.

The Court of Appeals for the Sixth Circuit, to which an appeal in this case would lie, has adopted the end result approach of the step transaction doctrine. In Brown v. United States, 868 F.2d 859, 862-863 (6th Cir. 1989), the Court of Appeals for the Sixth Circuit stated as follows—

the essence of the step transaction doctrine is that an “integrated transaction must not be broken into independent steps or, conversely, that the separate steps must be taken together in attaching tax consequences”.

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Under the end result test of the step transaction doctrine, “purportedly separate transactions will be amalgamated into a single transaction when it appears that they were really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate result.” King Enters., Inc. v. United States, 418 F.2d at 516. * * *

Here the parties have stipulated the following facts with regard to the transfer of lof’s glass division and the change in ownership of LOF Glass.

Late in 1985, representatives of Pilkington approached LOF concerning acquisition of lof’s glass division. During November of 1985 through early March of 1986, negotiations regarding the possible acquisition took place.

On March 6, 1986, LOF transferred the glass division to LOF Glass, the new subsidiary that had been formed for that purpose. One day later, on March 7, 1986, LOF entered into a 45-page agreement to transfer to Pilkington Holdings all of its stock interest in LOF Glass in exchange for Pilkington Holdings’ stock interest in LOF.

The March 7, 1986, agreement to exchange stock expressly refers to the March 6, 1986, transfer of the glass division to lof Glass and establishes the integrated nature of these transactions.

Seven weeks later, on April 28, 1986, the exchange of stock that had been agreed to on March 7, 1986, was consummated.

After April 28, 1986, LOF Glass was no longer part of LOF’s affiliated group and no longer was included in LOF’s consolidated Federal income tax return.

It is apparent that the transfer of the glass division to lof Glass and the agreement 1 day later to transfer the stock of lof Glass outside the lof affiliated group constituted an integrated transaction intended to move the glass division (and the related section 38 property) outside of LOF’s affiliated group.

Based on this stipulated factual record and on this issue on which petitioner has the burden of proof, see Rule 142(a), only one. conclusion can be reasonably reached — namely, that in spite of the qualification of the transaction as a reorganization under section 368(a)(1)(D) (allowing LOF to avoid recognizing taxable gain or loss on the transfer of the glass business and allowing LOF and Pilkington Holdings to avoid recognizing taxable gain or loss on their exchange of stock), the substance of the integrated transaction by which LOF’s glass division in 1986 was transferred outside the LOF affiliated group constituted a disposition of property under section 47 and triggered recapture of investment tax credit on any section 38 property that was included with the property transferred.

Section 1.1502-3(f)(3), Example (5), Income Tax Regs., simply is not applicable. That example involved, in year 1, only a transfer of property within the affiliated group. After the transfer, the property stayed within the affiliated group and was included in the consolidated return for the remainder of year 1. In year 2, no further transfer of property occurred. Rather, in an apparently unrelated transaction, a third party purchased the stock of the transferee, and the transferee, which had received the property in year 1, left the affiliated group. For the first time in year 2, the property will not be included in the consolidated return of the affiliated group.

The transaction described in Example (5) of the above regulation bears little resemblance to that involved in this case (where a transfer of property and a change in ownership of the transferee corporation occur effectively within the same taxable year as part and parcel of a single plan and transaction under which the transferee corporation promptly leaves the affiliated group and is no longer part of the affiliated group for purposes of inclusion in the transferor corporation’s consolidated tax return). Example (5) of the above regulation under the consolidated return regulations should not be read to immunize the integrated transaction before us from recapture under section 47.

It bears noting that the facts of the instant transaction are distinguishable from the facts of Salomon, Inc. v. United States, 976 F.2d 837 (2d Cir. 1992), and Walt Disney Inc. v. Commissioner, 4 F.3d 735 (9th Cir. 1993). Although the spinoffs in those cases resulted in a change in the identity of the corporate holder of the section 38 property, that property remained in the same economic family, with the same shareholders holding the stock of the new corporate owner of the section 38 property. In the instant case, at the inception of the transactions, Pilkington held only a 29-percent interest in the stock of lof. As a result of the completion of the splitoff, Pilkington acquired a 100-percent interest in the stock of LOF Glass, reflecting a 71-percent shift in the ownership of the corporation owning the section 38 property after the splitoff.

For the reasons stated herein and in the above opinions of the Courts of Appeals, I dissent.

Jacobs, Wells, Ruwe, Beghe, and Vasquez, JJ., agree with this dissent.