Union Oil Co. of California v. United States

Cowen, Chief Judge,

delivered the opinion of the court: In this tax refund suit, which is before the court on a stipulation of facts by the parties for a decision on an issue of law, plaintiff seeks to recover $233,912.32 in Federal Documentary Stamp Taxes collected under Section 4321 of the Internal Revenue Code of 1954. We have concluded that the plaintiff is not entitled to recover.

The basic facts material to the resolution of the issue before the court may be briefly summarized. On April 29,1965, plaintiff Union Oil Company of California (Union), a California corporation, entered into an Agreement of Merger with the Pure Oil Company (.Pure), a corporation organized under the laws of the State of Ohio. Under the terms of the Agreement, which was written in conformance with the applicable statutory provisions of California and Ohio, Pure was to be merged into Union by a transfer of all of Pure’s corporate assets to Union, subject to the approval of the stockholders of each corporation as required by local state law. The Agreement further provided that each outstanding share of Pure’s common stock was to be converted into one share of the cumulative convertible preferred voting stock of Union on the effective date of the merger. The shareholders of the two corporations duly approved the Agreement of Merger. On July 16, 1965, in accordance with the Agreement, Pure merged into Union, and Union issued 9,953,715 shares of its cumulative convertible preferred voting stock directly to the former shareholders of Pure.

¡It is the position of the Government that the merger of the two corporations involved two transactions subject to the imposition of Federal Documentary Stamp Taxes. The first such transaction, the issuance by Union of 9,953,715 shares of its capital stock, required payment of $584,780.80 of original issue stamp taxes under Section 4301 of the 1954 Code. Plaintiff concedes that the latter tax was properly assessed. The Government further asserts that plaintiff was liable for an additional $233,912.32 of transfer stamp taxes imposed by Section 4321 of the 1954 Code,¹ based on the implied transfer by Pure to its own shareholders of the right to receive 9,953,715 shares of Union stock issued in exchange for the assets of Pure. It is the assessment of the Section 4321 transfer stamp tax that plaintiff challenges here. Defendant asserts that Treasury Kegulation (26 C.F.R) •Section 47.4321-2(a)(9) is controlling. That regulation provides:

§ 47.4321-2 Illustrations.

(a) Sales and transfers subfeet to tax. The following transfers of stock are illustrations of transactions which are taxable, unless exempt from tax under a specific provision of the Internal Eevenue Code * * *:

^ *

(9) In addition to the tax on the issuance of stock in connection with a merger or consolidation, where such stock is issued directly to the stockholders of the merging or consolidating corporations by the continuing or consolidated corporation * * *, there is also a transfer tax imposed at the time of the issuance of such stock. The transfer tax is applicable to such a transaction inasmuch as there is involved the transfer to the stockholders of the merging or consolidating corporations of such corporations’ right to receive the stock of the continuing or consolidated corporation. * * * [Emphasis added.]

Simply stated, the Government’s theory is that the non-surviving corporation, here Pure, initially had the right to receive the capital stock of Union issued in exchange for the assets of Pure. This is because the corporation, rather than its individual stockholders, is the owner of the corporate assets. See h. henn, law or coepokations § 79 (2d Ed. 1970). Consequently, when Union and Pure agreed that incident to their merger Union would issue its capital stock directly to the shareholders of Pure, the merging corporation, there was an implied transfer by Pure to its own stockholders of the right to receive the Union capital stock. Defendant finds support for its position and for the above-quoted regulation, in the decision of the Supreme Court in Raybestos-Manhattan, Inc. v. United States, 296 U.S. 60 (1935). In that case the corporate taxpayer was organized under the laws of New Jersey as part of a plan of consolidation. Pursuant to the consolidation agreement, two preexisting corporations transferred their assets to the taxpayer and in return the taxpayer issued its capital stock directly to the shareholders of the two consolidating corporations. The Internal Eevenue Service assessed both original issue and transfer stamp taxes on the transactions. The transfer tax was assessed, as here, on the implied transfer by the consolidating corporations to their stockholders of the right to receive the stock of the new corporation. In construing the transfer stamp tax statute, similar to Section 4321, the Court held that when the act referred to transfers, it did not mean exclusively an actual transfer from the hand of the transferor to that of the transferee. The statute also referred to the relinquishment of a right by one party and the vesting of the same right in another. The Court stated:

* * * In the present case the generating source of the right to receive the newly issued shares of petitioner was the conveyance to it of the property of each of the corporations to be consolidated. The new shares could not lawfully be issued to any other than the grantor corporation without its authority, and that authority could not be exercised for the benefit of third persons other than its own assenting stockholders. The consolidation agreement thus imposed the duty on petitioner to issue the new shares upon receipt of the property, and at the same time made disposition to the stockholders of the two corporations of the correlative right to receive the stock. [296 U.S. at 68; emphasis added.]

The Court concluded that there was not “even a technical difference of any significance” for Federal tax purposes whether the shares were issued first to the consolidating corporations and later transferred to their stockholders, or whether the initial issuance of the stock and the transfer thereof to the shareholders of the consolidating corporations were effected in the single consolidation agreement. Although the Baybestos-Mcmhattan case arose in the context of a corporate consolidation, its principles have been applied in the traditional merger situation. U.S. Industrial Chemicals, Inc. v. Johnson, 181 F. 2d 413 (2d Cir. 1950); American Processing & Sales Co. v. Campbell, 164 F. 2d 918 (7th Cir. 1947), cert. denied, 333 U.S. 844 (1948); American Mail Line Ltd. v. United States, 121 Ct. Cl. 63, 101 F. Supp. 364 (1951) ; Western Massachusetts Elec. Co. v. United States, 101 F. Supp. 544 (D. Mass. 1951).

Plaintiff recognizes that Baybestos-Manhattan and the cases following it are controlling as to the applicability of ■the transfer stamp tax in the usual merger situation. However, plaintiff asserts that the critical factor in each of those cases was that under the applicable state laws respecting mergers and consolidations, the nonsurviving corporation in a merger or consolidation had the right to receive and the correlative right to control the disposition of the stock issued in exchange for its assets by the continuing corporation. Thus, plaintiff contends that, while the application of the transfer stamp tax to a particular transaction is a question of Federal law, the form of the transaction is controlled by state law and the tax is assessed on the basis of state-created relationships. Plaintiff also maintains that the law of Ohio with respect to mergers and consolidations, which was applicable to the merger of Pure into Union, prohibits the merging or nonsurviving corporation from receiving or controlling the disposition of the shares issued by the continuing corporation. Consequently, says plaintiff, tlie shareholders of the merging corporation have the exclusive right to receive such stock. The law of Ohio, plaintiff argues, precludes the possibility of any actual or implied transfer by the merging corporation to its stockholders of the right to receive the shares of the continuing corporation, and the transfer stamp tax of Section 4321 cannot be imposed.

Plaintiff claims support for its basic position in the decision of the United States Court of Appeals for the Fifth Circuit in Union Bankers Ins. Co. v. United States, 317 F. 2d 598 (5th Cir. 1963). That case concerned the merger, in accordance with the law of the State of Texas, of two Texas insurance corporations. The agreement of merger directed the issuance of the stock of the continuing corporation directly to the shareholders of the merging corporation in exchange for the assets of the latter. The Internal Revenue Service 'assessed the Section 4321 transfer stamp tax on the basis of the implied transfer by the merging corporation to its shareholders of the right to receive the capital stock of the continuing corporation. The court of appeals reversed the decision of the district court in favor of the 'Government. The court noted that Texas, like most other jurisdictions, stringently regulates by statute the activities of insurance companies doing business in the state. The court then concluded that the provisions of the Texas Insurance Code prohibited one insurance corporation from owning, possessing, or controlling the capital stock of any other insurance company at any time, even momentarily. Consequently, the court decided that in a merger situation, the acquired corporation had no right to receive, and no right to control the disposition of, the capital stock issued by the continuing corporation where both were insurance corporations. Thus, the court disallowed the imposition of the transfer stamp tax on the ground that “in this unusual situation” the applicable Texas law rendered impossible any transfer by the merging corporation to its shareholders of the right to receive the stock of the continuing corporation.

Turning to the law of Ohio pertaining to mergers and consolidations, plaintiff concedes that, unlike the Texas Insurance 'Code in Union Bankers, no provision of the Ohio statutes expressly precludes the acquired corporation in a merger from receiving or controlling the shares of the continuing corporation issued in exchange for its assets. However, plaintiff asserts that several of the merger and consolidation provisions can reasonably be read to support such a prohibition and that the courts and commentators in Ohio have so construed the statutes. We have considered the Ohio authorities and hold that they do not support plaintiff’s theory of recovery.

The provisions of the Ohio statutes regarding corporate mergers and consolidations are found at Sections 1701.78 through 1701.85 of the Ohio Revised Code.² Plaintiff particularly relies on Sections 1701.78(B) (10) and 1701.81(A) (1), which provide, in pertinent part, as follows:

§ 1701.78 Merger and consolidation procedure.

* * .1: ¡!¡ *

(B) To effect such merger or consolidation, the directors of each constituent corporation shall approve an agreement * * *, which agreement shall set forth:

$ * $ * $

.(10) * * * [T]he manner and basis of making distribution to shareholders of the constituent corporations, which distribution to shareholders of any of the constituent corporations, in extinguishment of or in substitution for shares of such constituent corporations, may be by way of shares * * * of the surviving or new corporation * * *.

$ ‡ ‡ $

§ 1701.81 Effect of merger.

(A) When such merger or consolidation becomes effective:

(1). The separate existence of all the constituent corporations, except the surviving or new corporation, shall cease * * *.

Plaintiff argues that under Section 1701.81(A)(1) a corporation which has ceased to exist as a separate legal entity on the effective date of the merger cannot, as a matter of inexorable logic, be tbe recipient of tbe stock issued by tbe surviving corporation. Therefore, plaintiff asserts, tbe Ohio legislature has provided in Section 1701.78(B) (10) that prior to tbe effective date of tbe merger, tbe agreement of merger must provide for distribution of tbe shares of tbe surviving corporation directly to the stockholders of tbe merging corporation. Since only tbe stockholders, under this reading of tbe statutes, have tbe right to receive tbe stock, there can be no taxable transfer of that right. While conceding that this is not tbe only reasonable construction of tbe statutes, plaintiff contends that it has been tbe interpretation thereof made by tbe Ohio courts.

Plaintiff refers us to Robison v. Cleveland City Ry. Co., 13 Ohio Dec. (10 Nisi Prius Rep.) 1 (Cuyahoga Common Pleas 1902). Plaintiff asserts that in that case, the court held that an agreement of consolidation providing for tbe issuance of the shares of the new corporation to the acquired corporation itself was invalid or unenforceable. That the Robison case represents the current law of Ohio, plaintiff suggests, is indicated by the statement at 13 Ohio Jur. 2d, Corporations §810(1955), which provides, in part, as follows:

* * * The shares of the new company must be delivered or distributed directly to the shareholders of the constituent corporations or their authorized agents. A delivery of the shares to the constituent corporations cannot be made, inasmuch as after the consolidation or merger becomes effective those corporations do not remain in existence for any such purpose. (Footnotes omitted.)

The commentary cites only the Robison case as authority for the quoted proposition.

We do not believe, however, that the Ohio statutes preclude the existence of an implied transfer by the merging corporation to its shareholders of the right to receive the stock issued in exchange for its assets by the surviving corporation. To the contrary, we think that the Ohio statutes recognize the existence of such a transfer and require that it be effected in the terms of the agreement of merger executed by the corporations involved and approved by their stockholders, prior to the effective date of the merger. It is especially significant that in Section 1701.78 (13) (10) of the Ohio Eevised Code, supra, the statute requires the directors of the corporations to specify in their agreement the manner by which the shares of the continuing corporation will be issued to the former shareholders of the merging corporation. It seems clear that the statute thereby acknowledges the power of the merging corporation to direct the disposition of the shares given in exchange for its assets, and by implication, the underlying right of the merging corporation to receive those shares.

The provision of Ohio law that the separate existence of the merging corporation will cease is not unique; that is the usual result of a corporate merger. This point indicates the critical fallacy of plaintiff’s argument. It is precisely because the merging corporation will cease to exist that the legislatures of the states normally require that such details as distribution of the stock of the surviving corporation be worked out prior to the effective date of the merger. Virtually the same argument 'as that made by the present plaintiff was before the Seventh Circuit in American Processing & Sales Co. v. Campbell, supra. That case involved a merger in accordance with the law of the State of Illinois which is substantially similar to the Ohio statute, and the agreement for the merger closely resembles the agreement for the merger of Pure and Union. As here, the main issue was the propriety of the assessment of the transfer stamp tax. The taxpayer argued that under Illinois law the merging corporation went out of existence and had no right to receive the stock of the continuing corporation; therefore, it had nothing to transfer to its stockholders. The court rejected this contention, noting that prior to the effective date of the merger the two corporations, with the consent of their stockholders, had adopted a plan of merger providing for the transfer of the assets of the merging corporation to the surviving corporation. The quid pro quo of this transfer of assets was to be the issuance of stock by the continuing corporation to the former shareholders of the •merging corporation. Consequently, the shareholders acquired the right to receive the stock by virtue of the terms of the agreement of merger between the corporations. Therefore, the court decided that the agreement effected a transfer of the right to receive the stock within the meaning of the taxing statute.

Similar principles were applied in the case of a vertical merger in U.S. Industrial Chemicals, Inc. v. Johnson, supra. See also, American Mail Line Ltd. v. United States, supra, 121 Ct. Cl. at 74-76, 101 F. Supp. at 368-369.

The Robison case in the Ohio Common Pleas Court, on Which the plaintiff relies, was one of several suits brought against Cleveland City Eailway Company (Eailway) by the shareholders of the Cleveland City Cable Eailway Company (Cable) ¡following the consolidation between Cable and another company to form the Cleveland City Eailway Company. The merging corporations entered 'into a consolidation agreement which provided that 18,250 shares of the nerw corporation were to be issued to Cable. After a sufficient number of the shares were sold to liquidate its indebtedness, Cable was to distribute the remainder among its stockholders. Pursuant to the agreement, Eailway delivered to Eobison and Shipherd, who had been appointed agents of the shareholders and of Cable, a certificate representing the 18,250 shares. After the receipt of the certificate, Shipherd wrongfully converted some of the shares to his own use. Thereafter, Eobison sued Eailway for the recovery of his shares of stock that had been converted. One of the defenses raised by Eailway was that the consolidation agreement authorized it to deliver the stock to Cable company for distribution by it to its shareholders and that Eailway had therefore discharged its obligation. The Common Pleas Court rejected this defense and held that under the Ohio statute “the new stock could be delivered only to individual holders or their authorized agents.” It is upon this portion of the court’s decision that plaintiff places its principal reliance.

The question winch the Common Pleas Court had to decide was whether the new corporation was liable to the shareholders of one of the merging corporations for the negligent misdelivery of the stock to the person who wrongfully converted it. The court did not address the factor deemed so critical by the Supreme Court in Raybestos-Manhattan, supra, namely, that the “generating source” of the right to receive the stock issued by the new corporation was the transfer to it of the assets of the non-surviving corporation. In view of these circumstances and the provisions of the Ohio statutes, which are quoted above, we would have difficulty in accepting the decision of the Common Pleas Court as the basis for deciding the wholly different issue before us. However, any doubts raised by Robison have been removed because defendant has called our attention to a decision of the Ohio Supreme Court, which was handed down about one year later than Robison and holds directly to the contrary. It is the case of Cleveland City Ry. Co. v. First Nat'l Bank of New York, 68 Ohio State 582, 67 N.E. 1075 (1903). In that case, which involved the same agreement of consolidation as that before the Common Pleas Court in Robison, the plaintiff bank claimed to be the assignee of shares of the non-surviving corporation and sought to recover damages from the new corporation because of the wrongful conversion of the newly issued stock by Shipherd. In an unreported decision, the Cuyahoga County Common Pleas Court followed the decision in Robison and found the Cleveland City Railway Company liable. The decision was affirmed by the Ohio Court of Appeals, 22 Ohio Cir. Ct. Reports 165 (8th Cir. 1901). The Ohio Supreme Court reversed both decisions and held that the applicable Ohio statute

not only expressly empowered [the directors of the constituent corporation] to agree upon the manner of converting the capital stock of each of the constituent companies into that of the new company, but [also] they are invested with the widest discretion as to the details of the consolidation, which may not be specifically included in the words of the statute.

The Court then went on to hold that the agreement was valid; that it conformed to the applicable state statutes; that it was assented to by the shareholders, and that it was properly performed.

As a result of this holding by the Supreme Court of Ohio, we cannot accept the decision of the Common Pleas Court in Robison as authority for deciding the issue now before us. Unlike the Texas statutes before the Fifth Circuit in Union Bankers, supra, it is apparent that there is nothing in either fclie statutory or tlie decisional law of Ohio, as expounded by the highest court of that state, which denies the non-surviving corporation in a merger the right to receive or control the disposition of the shares issued in exchange for its assets. On the contrary, we find that the Ohio law supports the opposite conclusion and recognizes the existence of the implied transfer to the shareholders of a non-surviving corporation of the right to receive such stock.

For the reasons discussed above, we hold that the 1965 merger of Pure Oil Company into Union Oil Company of California gave rise to a taxable transfer by Pure to its own stockholders of the right to receive the newly issued shares of Union. The transfer documentary stamp tax imposed by Section 4321 of the Internal Eevenue Code of 1954 was properly assessed.

Upon the foregoing opinion, which contains the essential findings of fact as stipulated by the parties, the court concludes as a matter of law that the plaintiff is not entitled to recover, and the petition is dismissed.

1 At the time of the merger, §4321 (since repealed, effective January 1, 1966, by the Act of June 21, 1965, Pub. L. No. 89-44, § 401(a), 79 Stat. 148) provided, in pertinent part, as follows :

“Sec. 4321. Imposition of taco

There is hereby imposed on each sale or transfer of shares or certificates of stock, or of rights to subscribe for or to receive such shares or certificates, issued by a corporation, a tax * *

2 The merger ana consolidation provisions of the Ohio statutes are not unique. Substantially similar provisions have been enacted in other Jurisdictions. E.g. Burns’ Ind. Stat. Ann. §§ 25-230 through 25-236; Smith-Hurd Ill. Ann. Stat., c. 32, §§157.61 through 157.70; Ky. Rev. Stat. §§ 271.465 through 271.490; and Corporations Code, West’s Ann. Calif. Codes, §§4100 through 4124.