De Groff v. Commissioner

Mark E. DeGroff and Loveta S. DeGroff, Petitioners v. Commissioner of Internal Revenue, Respondent

De Groff v. Commissioner

Docket No. 2260-68

United States Tax Court

54 T.C. 59; 1970 U.S. Tax Ct. LEXIS 228;

January 26, 1970, Filed

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">*228 Decision will be entered for the respondent.

Petitioners (T and his wife) were the sole and equal stockholders in three corporations, M, P, and E. M manufactured therapeutic devices invented or developed by T, and P and E marketed such devices. As a result of an informal arrangement the entire business operation of E was taken over by P as of the close of their fiscal year ending Nov. 30, 1963. Thereafter all selling was carried on by P. In connection with the unification, some $ 120,000 was distributed to T and his wife. Held: In the circumstances of this case there was a reorganization under sec. 368(a)(1)(D), and the distributions were taxable to T and his wife as dividends under sec. 356(a)(2) rather than as capital gain realized on the liquidation of E under secs. 331(a) and 346. There was a transfer, albeit an informal one, of "substantially all" the assets of E to P, thereby satisfying the requirement of sec. 354(b)(1)(A), which was necessary for the transaction to qualify as a reorganization under sec. 368(a)(1)(D).

Lowry McKee, for the petitioners.

Harold Friedman, for the respondent.

">*231 Raum, Judge.

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RAUM

">*59 The Commissioner determined a deficiency of $ 48,372.16 in petitioners' income tax for 1964. The only issue is whether distributions by Medco Electronics Co., Inc., to its shareholders were liquidating distributions under sections 331 and 346, I.R.C. 1954, or whether such distributions were incident to a corporate reorganization and were taxable as dividends under section 356(a)(2).

FINDINGS OF FACT

The parties have stipulated certain facts, which, together with the attached exhibits, are incorporated herein by this reference.

Petitioners, Mark E. and Loveta S. DeGroff, are husband and wife; they were married in 1949. They filed a joint Federal income tax return for the calendar year 1964 with the district director of internal revenue in Oklahoma City, Okla., and resided in Tulsa, Okla., at the time the petition was filed in this case.

">*60 For a number of years Mr. DeGroff has been engaged in various activities relating to the invention, promotion, and exploitation of various therapeutic devices. Mrs. DeGroff has been active in such enterprises, in control of office management, bookkeeping, sales records, billing, and the like. In 1949, Mr. ">*232 DeGroff invented a device known as the Medcolator. The Medcolator is an electrical muscle stimulator. It is designed to perform electrodiagnosis, stimulation of innervated and denervated muscles, ion transfer, and medical galvanism. Between 1949 and April 1, 1955, the Medcolator was marketed by a partnership formed by the DeGroffs.

On April 1, 1955, petitioners incorporated Medco Products Co., Inc. (Medco Products), under the laws of the State of Oklahoma for the purpose of marketing electrical therapeutic equipment. At that time Medco Products assumed the task of marketing the Medcolator. On the same date, petitioners also incorporated Medco Products Mfg. Corp. (Medco Mfg.) under the laws of the State of Oklahoma for the purpose of manufacturing the equipment sold by Medco Products. Initially, the Medcolator was the only product handled by either corporation. Mr. and Mrs. DeGroff each owned 50 percent of the capital stock of both Medco Products and Medco Mfg., and served, respectively, as president and vice president of both corporations. Mr. DeGroff's principal efforts on behalf of Medco Products were devoted to product development, promotion, and sales, while his wife's ">*233 duties were primarily related to running Medco Products' business office.

Medco Products established a network of exclusive distributorships to market the Medcolator. Each distributor was given a portion of the United States throughout which he had the exclusive right to sell the Medcolator. The distributors themselves purchased the Medcolator units from Medco Products and then sold the units to physicians, hospitals, and clinics. The distributors earned a 50-percent "commission" or profit on each sale.

By 1955, the Medcolator was threatened by competition from therapeutic devices which used "ultrasound" ^{1970 U.S. Tax Ct. LEXIS 228">*234 by Medco Mfg.}

">*61 During Medco Electronics' first few years, Mr. DeGroff devoted a major portion of his time toward making the Medco-sonlator a commercially acceptable product. Much of his effort was devoted to exhibiting and demonstrating the Medco-sonlator at medical meetings and conventions throughout the country.

In marketing the Medco-sonlator, Medco Electronics used the same network of independent distributors employed by Medco Products; however, at least in some situations, a portion of an existing territory was carved out and assigned to a "division manager." The independent distributors continued to receive a 50-percent commission or profit, as in the case of the Medcolator, but the division managers, or salesmen, received a commission of only 33 1/3 percent. Thus the distribution network, as modified for Medco Electronics, enabled the DeGroffs to market the Medco-sonlator through an expanded sales force and at partly reduced commission rates when sales were made ">*235 by employees rather than independent distributors. The Medcolator, however, continued to be marketed by Medco Products exclusively through the old distributors. The parties have stipulated that a total of 966 Medco-sonlators were sold during Medco Electronics' fiscal year ended November 30, 1963, as follows:

	Units
	sold
By 42 independent distributors	939
By salaried employees of Medco Products Co., Inc	17
As a result of direct inquiry	10
	966

A certain amount of training was necessary before the distributors and division managers were able to demonstrate the Medco-sonlator to prospective customers. Thus, as Mr. DeGroff developed the distribution network, he instructed the distributors and division managers in the operation of the machine. As a result he was gradually able to shift the burden of displaying the machines throughout the country to the distributors and division managers.

On January 31, 1957, Mr. DeGroff filed an application for a patent covering the Medco-sonlator, patent No. 2,830,578, entitled "Electro-Sonic Apparatus," was issued to him on April 15, 1958. On May 1, 1958, he granted to Medco Electronics an exclusive license to "make and sell" and ">*236 a nonexclusive license to "use" devices embodying the patented invention. The license agreement gave Medco Electronics the right to sublicense under the agreement. With respect to assignability, it provided:

">*62 VI. ASSIGNABILITY:

This agreement and the license granted hereunder are personal to the parties. This agreement shall be binding upon and inure to the benefit of the parties and to their successors in interest, heirs, assigns and transferees.

Furthermore, Medco Electronics was given the right to bring suit and recover damages on the patent covering the Medco-sonlator.

The agreement contained no requirement for the payment of royalties, and in respect of "consideration," it provided simply that --

LICENSEE agrees to pay LICENSOR Ten Dollars ($ 10.00) and other valuable consideration for the rights granted herein, and said other consideration being in part that it will provide an extensive commercial promulgation of the apparatus embodied in said Patent aforesaid, and will exercise its best endeavors to continually market and sell the apparatus under the Patent aforesaid.

The license agreement also declared that it would remain in effect for the life of the patent, ">*237 but that in the event of Medco Electronics' failure to comply with its covenant to market the Medco-sonlator, DeGroff was given the right to cancel the agreement on 60 days' written notice.

Despite the exclusive nature of the agreement, Medco Mfg. rather than Medco Electronics made or assembled the Medco-sonlator and continued to do so at the time of the trial herein. No evidence of a sublicense agreement between Medco Electronics and Medco Mfg. was offered at the trial herein.

During the years following the organization of Medco Electronics, DeGroff developed a number of other therapeutic devices. Each was assembled or manufactured by Medco Mfg. and marketed by Medco Products. ^{1970 U.S. Tax Ct. LEXIS 228">*238 Medco Products and Medco Electronics shared the same general business office and the same office employees. Under Mrs. DeGroff's direction the office handled the standard "home office" operations of both corporations, such as correspondence, processing of orders, purchasing, billing, bookkeeping, and banking. Separate books, bank accounts, invoices, bills, and stationery were used in the operations of each corporation. However, orders written or telephoned in to the office for either corporation's products were all handled identically, except that the office workers used the invoices, bills, and stationery of the corporation marketing the product ordered.}

">*63 With the exception of officers' salaries, payroll taxes, and sales commissions, Medco Products paid all salary and office expenses on behalf of both corporations. At the end of each month, Medco Products billed Medco Electronics for its prorata share of these expenses, based upon its percentage of total sales for that month.

Neither Medco Products nor Medco Electronics carried any inventory. Equipment was obtained from Medco Mfg. only as it was sold.

The same advertising agency was employed by both corporations. It">*239 billed them jointly, and the bill was paid by Medco Products. Although the Medco-sonlator was not always advertised together with Medco Products' wares, Medco Products billed Medco Electronics for the advertising according to its percentage of their joint sales.

By 1963, the Medco-sonlator had received FCC approval and had become successfully established both medically and commercially. The absence of these considerations had theretofore been thought to justify the marketing of this device through a separate corporation. In these circumstances and in view of the fact that the continued existence of Medco Electronics required them to maintain separate records and to print separate bills, invoices, and stationery on its behalf, the DeGroffs decided that Medco Electronics should cease to do business and that Medco Products should market the Medco-sonlator thereafter. The corporate affairs of Medco Electronics were ordinarily conducted loosely on an informal basis, and there are no minutes reflecting the DeGroffs' decision.

On November 30, 1963, at the close of its fiscal year, Medco Electronics ceased marketing the Medco-sonlator. On that date it had accumulated earnings and profits">*240 of $ 124,030. Its balance sheet, as reflected by its books, was as follows:

Assets
Cash (cash in bank and certificates of deposit)		$ 70,653.74
Accounts receivable:
Trade	$ 32,592.91
Medco Products Mfg. Corp	60,137.99	92,730.90
Due from shareholders		64,636.51
Deposit -- payroll taxes		601.20
Total		228,622.35
Liabilities
Account payable -- Medco Products Co., Inc		$ 99,236.91
Taxes payable		4,855.44
Capital
Capital stock	$ 500.00
Retained earnings	124,030.00	124,530.00
Total		228,622.35

">*64 Thus, on November 30, 1963, Medco Electronics held accounts receivable totaling $ 92,730.90 and an account payable to Medco Products of $ 99,236.91. In order to satisfy part of its debt to Medco Products it transferred all of its accounts receivable to Medco Products. The remaining $ 6,506.01 debt was satisfied by a $ 30,000 "advance" to Medco Mfg. and a transfer to Medco Products of Medco Mfg.'s resulting obligation in return for cash and elimination of the remaining debt.

More specifically, the parties have stipulated that the cash balance of $ 70,653.74 was reduced to $ 59,893.49 as follows:

Cash balance Nov. 30, 1963		$ 70,653.74
Add:
Receipt of cash from Medco Products Co., Inc.
(from "sale" of accounts receivable to it)		23,505.92
Total		94,159.66
Deduct:
Advances to Medco Products Mfg. Corp	$ 30,000.00
Payment of various taxes as shown on
the balance sheet of Nov. 30, 1963
($ 4,855.44 less application
of $ 601.20 deposit)	4,254.24
Interest paid	11.93
Total		34,266.17
Cash distributed to shareholders		59,893.49

">*241 The accounts receivable of $ 92,730.90 were disposed of as follows:

Accounts receivable balance Nov. 30, 1963		$ 92,730.90
Add:
Advances to Medco Products Mfg. Corp.:
Dec. 26, 1963	$ 10,000.00
Jan. 3, 1964	5,000.00
Jan. 10, 1964	15,000.00	30,000.00
Interest paid, charged to Medco Products Co., Inc		11.93
Total		122,742.83
Disposition:
Used to "pay" or "offset" the account payable to Medco
Products Co., Inc., as shown on the balance
sheet dated Nov. 30, 1963		$ 99,236.91
"Sold" to Medco Products Co., Inc., for cash		23,505.92
Total		122,742.83

During 1964, the DeGroffs received distributions totaling $ 124,530 from Medco Electronics, consisting of $ 59,893.49 in cash and cancellation of the $ 64,636.51 debt due from shareholders, as reflected ">*65 on the balance sheet of November 30, 1963. The cash distributions were made as follows:

Date	Amount
Feb. 14, 1964	$ 22,447.33
Mar. 23, 1964	464.85
Apr. 24, 1964	10,000.00
July 19, 1964	15,000.00
Aug. 6, 1964	1,200.00
Aug. 28, 1964	10,781.31
Total	59,893.49

The amount due from the DeGroffs was canceled on an unspecified date in 1964.

Medco Electronics was not">*242 formally dissolved. Rather, its charter was simply allowed to lapse by nonpayment of the State franchise tax.

In addition to assets appearing on its balance sheet as of November 30, 1963, Medco Electronics had a valuable intangible asset, a going-concern value, in the successful operation of the business of selling a product which enjoyed public acceptance through an established sales distribution network. Its sales record for its fiscal years 1956-63 is shown in the following table:

MEDCO ELECTRONICS CO., INC.
Sales Broken Down By Sales of the Medco-sonlator and Minor Accessories
For the year ended Nov. 30 --	Medco-sonlators	Minor	Total
		accessories
1956	$ 357,082.64	$ 16,464.40	$ 373,547.04
1957	380,443.45	18,780.24	399,223.69
1958	494,002.65	37,049.58	531,052.23
1959	590,560.29	49,906.45	640,466.74
1960	478,494.29	45,882.65	524,376.94
1961	537,204.80	49,046.00	586,250.80
1962	479,643.27	42,284.31	521,927.58
1963	526,529.29	38,911.95	565,441.24
Total	3,843,960.68	298,325.58	4,142,286.26

At the time its business was transferred to Medco Products, Medco Electronics made no attempt to assign its license agreement or ">*243 to grant any sublicense under it. Neither DeGroff alone nor the DeGroffs together ever formally granted Medco Products any rights under it.

After November 30, 1963, the Medco-sonlator was marketed solely by Medco Products. However, there was no substantial change in the daily operations of the business. Although the independent distributors were not contractually obligated to continue to sell the Medco-sonlator, the distributors and other sales personnel who had marketed the Medco-sonlator on behalf of Medco Electronics continued to sell it on Medco Products' behalf. The office employees who had previously processed orders for the Medco-sonlator continued to do so just as they had before. The only change was that the invoicing, billing, correspondence, and advertising was performed in the name of Medco ">*66 Products rather than Medco Electronics. Moreover, since advertising circulars for the Medco-sonlator both before and after November 30, 1963, featured the trade name, "Medco-sonlator," rather than the name of Medco Electronics or Medco Products, it appears that the transfer had little, if any, effect on the promotion of the Medco-sonlator. In fact, a 1964 advertising ">*244 circular with respect to the Medco-sonlator and other products erroneously referred to them merely as "Manufactured by Medco Products Co., Inc.," and an earlier circular with respect to another product was issued in the name of "Medco Electronics Company, Inc., Division/Medco Products Co., Inc.," an erroneous designation. The corporate names were used loosely and the identity of the particular corporate entity promoting the sale of the Medco-sonlator does not appear to have played any significant role in its success.

During 1964 DeGroff devoted 10 to 15 percent of his time to promotion of the Medco-sonlator. Between 1964 and 1968 the Medco-sonlator accounted for over 60 percent of Medco Products' dollar sales. Its sales of each of its products for each year of its existence through the year ended November 30, 1968, were as follows: ">*67

MEDCO PRODUCTS CO., INC.
Sales -- Broken Down by Products Sold
For the year		Accessories		Medco
ended Nov. 30 --	Medcolator	and others	Koltherm	lotion
1955	$ 187,953.79	$ 682.61
1956	78,079.31	7,274.11
1957	41,714.07	6,689.15
1958	36,520.88	11,577.41
1959	29,003.13	9,474.73
1960	37,447.42	15,897.43	$ 77,362.50
1961	29,772.73	20,481.38	34,336.97
1962	22,725.95	15,429.40	10,935.83	$ 11,660.57
1963	38,109.25	17,863.06	11,264.50	16,131.36
1964	36,773.74	60,155.37	8,321.25	17,816.02
1965	54,274.40	93,408.84	5,015.00	23,213.96
1966	61,763.13	112,745.48	850.00	26,871.75
1967	57,972.53	86,827.11	425.00	30,039.10
1968	69,913.04	100,204.15	435.00	33,913.61
Total	782,023.37	558,710.23	148,946.05	159,646.37

">*245

MEDCO PRODUCTS CO., INC.
Sales -- Broken Down by Products Sold
For the year	Kinemometer	Cardi-O-Mite	Achilleometer	Medcosonlator
ended Nov. 30 --
1955
1956
1957
1958
1959
1960
1961
1962	$ 29,996.00	$ 14,082.00
1963	19,920.50	24,707.00
1964		5,234.00	$ 158,179.80	$ 544,552.52
1965			158,305.15	614,657.49
1966			49,984.62	582,246.60
1967			40,499.00	509,283.90
1968			12,055.00	526,254.59
Total	49,916.50	44,023.00	419,023.57	2,776,995.10

MEDCO PRODUCTS CO., INC.
Sales -- Broken Down by Products Sold
For the year	Medcotherm	Fuel
ended Nov. 30 --		alert	Total
1955			$ 188,636.40
1956			85,353.42
1957			48,403.22
1958			48,098.29
1959			38,477.86
1960			130,707.35
1961			84,591.08
1962			104,829.75
1963			127,995.67
1964			831,032.70
1965			948,874.84
1966	$ 29,176.50		863,638.08
1967	60,420.00		785,466.64
1968	51,768.00	$ 6,225.25	800,768.64
Total	141,364.50	6,225.25	5,086,873.94

">*68 On their joint Federal income tax return for the calendar year 1964, the DeGroffs reported $ 122,296.58 as long-term capital gain from the "liquidation of Medco ">*246 Electronics Co., Inc." That amount consisted of the $ 124,530 received from Electronics, less $ 500, the basis of their capital stock, and less $ 1,733.42 additional income taxes assessed against Medco Electronics after November 30, 1963, and paid personally by the DeGroffs.

In his notice of deficiency, the Commissioner determined that the transfer of assets from Medco Electronics to Medco Products constituted a reorganization of the two corporations and that therefore the net distribution of $ 122,296.58 was taxable to the DeGroffs as ordinary income rather than capital gain.

OPINION

Petitioner Mark E. DeGroff is an inventor who has been engaged in the development and exploitation of therapeutic devices. The first such device of any consequence was the so-called Medcolator, which was marketed by a partnership in which DeGroff and his wife each had a 50-percent interest. In 1955 he invented another device named the Medco-sonlator, and in that year three corporations were organized, the stock in each of which was owned equally by both spouses. One was a manufacturing corporation (Medco Mfg.) which produced the Medcolator, the Medco-sonlator, and various other devices invented by ">*247 DeGroff. The second was a selling corporation (Medco Products), which promoted and sold the Medcolator and other products invented by DeGroff, except the Medco-sonlator. The third was also a selling corporation (Medco Electronics), which promoted and sold the Medco-sonlator. Although separate records were kept for each corporation, their affairs in respect of one another appear to have been conducted in an informal and rather loose manner. The term "Medco" was the unifying descriptive word that characterized the entire enterprise, and the great bulk of the gross receipts was attributable to products which embodied that term in their names. The Medco-sonlator turned out to be the most profitable product, and the DeGroffs decided informally to combine the activities of both selling corporations in a single corporation as of the close of November 30, 1963, the end of the fiscal year of both Medco Products and Medco Electronics. The unification was achieved by having Medco Products take over all of the activities and functions of Medco Electronics as of December 1, 1963. No formal transfer was made, but all the functions and activities of Medco Electronics were continued without">*248 a break by Medco Products in an identical manner with the same personnel. The only change was a purely formal one in that invoices and other ">*69 records were issued in the name of Medco Products, and bank accounts and other records were maintained in the name of but a single corporation, Medco Products.

At the time of the combination of both these corporations Medco Electronics had accumulated earnings and profits in the amount of $ 124,030, and, in connection with the merger of their activities, the DeGroffs received distributions in the full amount of such surplus. Had there been no transfer of Medco Electronics' functions to Medco Products, there is no serious question that such distributions would have been treated as dividends to the DeGroffs, taxable as ordinary income. Is a different result called for merely because such earnings and profits were siphoned out of the enterprise in the manner described above? We hold that the answer must be in the negative and that the determination of deficiency must be sustained.

Petitioners' contention is that there was a liquidation of Medco Electronics and that the amount received by them represents merely payment for their Medco">*249 Electronics stock, with the consequence that the net profit reflected therein is taxable only at the more favorable capital gains rates. They rely upon sections 331(a) and 346(a)(1) of the 1954 Code. ^{54 T.C. 59">*70 supported by accumulated corporate earnings and profits. Cf. John G. Moffatt, 42 T.C. 558">42 T.C. 558,">*250 affirmed 363 F.2d 262 (C.A. 9), certiorari denied 386 U.S. 1016">386 U.S. 1016; Davant v. Commissioner, 366 F.2d 874 (C.A. 5), affirming in this respect 43 T.C. 540">43 T.C. 540, 43 T.C. 540">568-572, certiorari denied 386 U.S. 1022">386 U.S. 1022, rehearing denied 389 U.S. 893">389 U.S. 893; James Armour, Inc., 43 T.C. 295">43 T.C. 295.}

">*251 The statute is complicated, but a careful study thereof leads to the foregoing conclusion. The critical provisions are set forth in sections 354(a) and (b), 356(a)(1) and (2), and 368(a)(1) of the Code. Section 368(a)(1) ^{1970 U.S. Tax Ct. LEXIS 228">*252 contains the definition of a reorganization, and sections 354 and 356, 54 T.C. 59">*71 consequences of a reorganization. In terms of the present case, the Government contends, and we hold, that there was a "reorganization" under section 368(a)(1)(D), with the result that under section 356(a)(2), an exchange in a reorganization having the effect of the distribution of a dividend must be treated as a dividend to the extent recognized and to the extent that it is supported by undistributed corporate earnings and profits.}

">*253 If there were a reorganization as defined in section 368(a)(1)(D), as contended by the Government, we have no doubt that the distributions before us must be treated as a dividend under section 356(a)(2), and we reject petitioners' suggestion that Moffatt, Davant, and Armour

* * * *

(D) a transfer by a corporation of1970 U.S. Tax Ct. LEXIS 228">*254 all or a part of its assets to another corporation if immediately after the transfer the transferor or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356; * * *

There was here a transfer of assets by Medco Electronics to Medco Products -- albeit an informal one -- and immediately after the transfer the two sole stockholders were in complete control of the transferee. So much is not disputed, and the requirements set forth in section 368(a)(1)(D) appear to have been met. 54 T.C. 59">*72 incorporates section 354 by reference, and the critical disagreement between the parties is whether Medco Products acquired "substantially all" of the assets of Medco Electronics so as to satisfy the requirement of section 354(b)(1)(A).

">*255 In several recent cases we have considered the meaning of "substantially all" of the assets as used in section 354(b)(1)(A). In John G. Moffatt, 42 T.C. 558">42 T.C. 558, 42 T.C. 558">578, affirmed 363 F.2d 262 (C.A.9), certiorari denied 386 U.S. 1016">386 U.S. 1016, we noted that "it must be remembered that the 'substantially all' requirement 'has been subjected to [a] construction which in effect applies a continuity test rather than mere blind percentages.'" In holding that section 354(b)(1)(A) had been satisfied notwithstanding that certain nonoperating assets had been distributed to the stockholders, we found --

[that] the necessary continuity was present here * * *. The * * * [transferor corporation's] business was transferred to the new company, bearing a similar name and controlled by the same persons. It employed the same personnel, used the same facilities, had the same address, and dealt with the same clients as though nothing had occurred apart from the minor change in name of the business. There was here the most complete continuity of enterprise -- the very kind of continuity that is basic to a corporate reorganization">*256 with its concomitant nonrecognition of gain or loss except for the distribution of "boot."

See also Werner Abegg, 50 T.C. 145">50 T.C. 145, 50 T.C. 145">157; Ralph C. Wilson, Sr., 46 T.C. 334">46 T.C. 334, 46 T.C. 334">345-348; James Armour, Inc., 43 T.C. 295">43 T.C. 295, 43 T.C. 295">308-310.

In the case before us, it is perfectly clear that as a practical matter the business of Medco Electronics was completely taken over by Medco Products. Prior to November 30, 1963, Medco Products and Medco Electronics had conducted their businesses jointly; they had marketed their products through an overlapping sales network and had distributed them through the same office staff. The transfer of the Medco-sonlator sales operation to Medco Products merely allowed the corporate structure of the DeGroffs' enterprise to conform to the way in which its daily operations were already organized. Thus, the transfer had not one significant effect upon the daily activities of the DeGroffs' enterprise. The sale and distribution of the Medco-sonlator continued to be handled by the same personnel, at the same location, and in the same manner as they had been before the transfer. Furthermore, ">*257 the similarity of the names of the two corporations and the fact that the trade name, "Medco-sonlator," rather than the name of the corporation selling it, was featured on the DeGroffs' advertising circulars enabled Medco Products to continue to benefit from whatever reputation the Medco-sonlator previously enjoyed.

However, petitioners contend that the "substantially all" requirement has not been satisfied since Medco Electronics' most valuable assets, its rights under its exclusive license agreement with DeGroff, ">*73 its sales network, and the availability of DeGroffs' services, were not "transferred" to Medco Products. Although none of these assets appeared on Medco Electronics' balance sheet, it is conceded by both parties, and we agree, that intangible assets not appearing on the transferor corporation's balance sheet may properly be considered in determining whether "substantially all" of its assets have been transferred. Ralph C. Wilson, Sr., 46 T.C. 334">46 T.C. 345-348; John G. Moffatt, 42 T.C. 558">42 T.C. 579. Nevertheless, to the extent that Medco Electronics had any rights in these intangibles it is our conclusion on this">*258 record that Medco Products succeeded to such rights in full.

Petitioners' principal contention is that Medco Electronics' exclusive license agreement with Mr. DeGroff in respect of the Medco-sonlator was nonassignable, that it was of substantial value, and that it was not in fact transferred to Medco Products. We think that this argument paints a false picture of the situation.

By May 1958, when the license agreement was signed, the right to sell the Medco-sonlator had already become a valuable commercial asset. During the fiscal years ending November 30, 1956, 1957, and 1958, Medco Electronics' sales of the Medco-sonlator totaled $ 357,082.64, $ 380,443.45, and $ 494,002.65, respectively. Yet under the terms of the license agreement, DeGroff granted Medco Electronics the exclusive right to manufacture and to sell the Medco-sonlator without reserving to himself the right to receive royalty payments in return. ^{1970 U.S. Tax Ct. LEXIS 228">*259 to make or assemble the Medco-sonlator just as it had for the past few years and just as it continued to do at the time of the trial herein. Nothing in the record even suggests that there was a sublicense to Medco Mfg. The license agreement was obviously not entered into at arm's length and clearly did not in fact govern and was not intended to govern the business relationships between Medco Electronics and DeGroff. The DeGroffs conducted their enterprise in a loose and informal manner, and it is all too clear to us that Medco Products succeeded ">*74 to whatever rights Medco Electronics may have had in respect of the Medco-sonlator. Certainly, Medco Products continued to sell the Medco-sonlator in the same manner that it had previously been marketed. DeGroff's testimony suggested that Medco Products was an infringer in this respect and that he merely permitted it to infringe. We heard that testimony, and the short answer is that we don't believe it. The simple truth lies in the informal manner in which the entire enterprise was conducted, and the fact that Medco Products was assigned the task of selling the Medco-sonlator after November 30, 1963, just as Medco Electronics">*260 had carried on before.}

">*261 Moreover, even if the license agreement were to be taken at face, it is highly questionable whether it was nonassignable. To be sure, it provided that it was "personal to the parties," but it also stated that it would be "binding and inure to the benefit of the parties and to their successors in interest, assigns and transferees." Obviously, as the corporate life of the Medco Electronics was allowed to be extinguished by petitioners, they, as sole stockholders of Medco Electronics at the very least became "successors in interest" to the license agreement, and, to the extent that it had any vitality it is clear to us that they made it available informally to Medco Products.

1970 U.S. Tax Ct. LEXIS 228">*262 Similarly, to the extent that Medco Electronics may have had any other intangible property rights that were not formally transferred, we are of the opinion that Medco Products succeeded thereto in the same kind of informal manner. Certainly, petitioners who have the burden of proof, have not convincingly shown otherwise. If such assets were not transferred, where did they go, and where are they now? Thus far, no answer has been suggested.

We hold that the "substantially all" requirement has been satisfied. The only assets which did not go over to Medco Products were distributions to petitioners that must be charged to them as dividends under section 356(a)(2).

">*75 The foregoing discussion has been predicated upon the assumption that the transfer of Medco Electronics' business to Medco Products must qualify as a reorganization under section 368(a)(1)(D) in order to bring 356(a)(2) into play. But we take note of another possibility, namely, that if the transfer was a reorganization under section 368(a)(1)(F), fn. 4, supra, the provisions of section 356(a)(2) would similarly be triggered, and under (F) there is no "substantially all" requirement. Moreover, the decisions">*263 of two Courts of Appeals strongly support the conclusion that there was an (F) reorganization here. Davant v. Commissioner, 366 F.2d 874, 883-884 (C.A. 5); Estate of Stauffer v. Commissioner, 403 F.2d 611 (C.A. 9), reversing 48 T.C. 277">48 T.C. 277; Associated Machine v. Commissioner, 403 F.2d 622 (C.A. 9), reversing 48 T.C. 318">48 T.C. 318. To be sure, the Government has not contended that there was an (F) reorganization here, but it would nevertheless be open to us to apply (F), ^{Wilkes-Barre Carriage Co., 39 T.C. 839">39 T.C. 839, 39 T.C. 839">845-846, affirmed 332 F.2d 421 (C.A. 2), "the rule is well established that a deficiency may be approved on the basis of reasons other than those relied upon by the Commissioner or even where his reasons may be incorrect. Blansett v. United States, 283 F.2d 474, 478-479 (C.A. 8); Bernstein v. Commissioner, 267 F.2d 879, 881-882 (C.A. 5); Acer Realty Co. v. Commissioner, 132 F.2d 512, 514-515">*264 (C.A. 8); Alexander Sprunt & Son v. Commissioner, 64 F.2d 424, 427 (C.A. 4); Crowell v. Commissioner, 62 F.2d 51, 53 (C.A. 6); J. & O. Altschul Tobacco Co. v. Commissioner, 42 F.2d 609, 610 (C.A. 5); Hughes v. Commissioner, 38 F.2d 755, 757 (C.A. 10); John L. Chipley, 25 B.T.A. 1103">25 B.T.A. 1103, 25 B.T.A. 1103">1106; Edgar M. Carnrick, 21 B.T.A. 12">21 B.T.A. 12, 21 B.T.A. 12">21; cf. Helvering v. Rankin, 295 U.S. 123">295 U.S. 123, 295 U.S. 123">132-133."}

However, when Stauffer and Associated Machine were before us we construed (F) differently, and since we have concluded that (D) is applicable, we find it unnecessary now to reexamine">*265 our views as to (F). In the circumstances we do not pass upon this point.

Decision will be entered for the respondent.

---

Footnotes

• 1. From 750,000 to 1 million cycles.↩

• 2. The parties have stipulated that the Medco-sonlator was the only product ever marketed by Medco Electronics. However, an advertising leaflet for the "Kol-Therm," a device invented by DeGroff for applying moist cold and moist heat therapy, lists Medco Electronics as the sales corporation. The leaflet was submitted as a joint exhibit, and the discrepancy is unexplained.↩

• 3. SEC. 331. GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS.

  (a) General Rule. --

  (1) Complete liquidations. -- Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock.

  (2) Partial liquidations. -- Amounts distributed in partial liquidation of a corporation (as defined in section 346) shall be treated as in part or full payment in exchange for the stock.

  (b) Nonapplication of Section 301. -- Section 301 (relating to effects on shareholder of distributions of property) shall not apply to any distribution of property in partial or complete liquidation.

  SEC. 346. PARTIAL LIQUIDATION DEFINED.

  (a) In General. -- For purposes of this subchapter, a distribution shall be treated as in partial liquidation of a corporation if --

  (1) the distribution is one of a series of distributions in redemption of all of the stock of the corporation pursuant to a plan * * *↩

• 4. SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.

  (a) Reorganization. --

  (1) In General. -- For purposes of parts I and II and this part, the term "reorganization" means --

  * * * *

  (D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356;

  * * * *

  (F) a mere change in identity, form, or place of organization, however effected.↩

• 5. SEC. 354. EXCHANGES OF STOCK AND SECURITIES IN CERTAIN REORGANIZATIONS.

  (a) General Rule. --

  (1) In general. -- No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.

  * * * *

  (b) Exception. --

  (1) In general. -- Subsection (a) shall not apply to an exchange in pursuance of a plan of reorganization within the meaning of section 368(a)(1)(D), unless --

  (A) the corporation to which the assets are transferred acquires substantially all of the assets of the transferor of such assets; and

  (B) the stock, securities, and other properties received by such transferor, as well as the other properties of such transferor, are distributed in pursuance of the plan of reorganization.

  SEC. 356. RECEIPT OF ADDITIONAL CONSIDERATION.

  (a) Gain on Exchanges. --

  (1) Recognition of gain. -- If --

  (A) section 354 or 355 would apply to an exchange but for the fact that

  (B) the property received in the exchange consists not only of property permitted by section 354 or 355 to be received without the recognition of gain but also of other property or money,

  then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.

  (2) Treatment as dividend. -- If an exchange is described in paragraph (1) but has the effect of the distribution of a dividend, then there shall be treated as a dividend to each distributee such an amount of the gain recognized under paragraph (1) as is not in excess of his ratable share of the undistributed earnings and profits of the corporation accumulated after February 28, 1913. The remainder, if any, of the gain recognized under paragraph (1) shall be treated as gain from the exchange of property.↩

• 6. Petitioners place considerable reliance in this respect upon Commissioner v. Gordon, 391 U.S. 83">391 U.S. 83↩, a case dealing with an entirely different problem and different statutory provisions. We think it has no controlling effect here.

• 7. To be sure, there was no distribution of stock or securities in exchange for the interests transferred; however, since the DeGroffs already owned all of the stock in Medco Products any issuance of additional stock would have been meaningless, and they do not contend that the failure to issue any such additional stock would render sec. 368(a)(1)(D) inapplicable. Indeed it has already been well established that no such exchange for their interest is required in such circumstances. See Ralph C. Wilson, Sr., 46 T.C. 334">46 T.C. 334, 46 T.C. 334">342-344; South Texas Rice Warehouse Co., 43 T.C. 540">43 T.C. 540, 43 T.C. 540">568-570, affirmed 366 F.2d 890 (C.A. 5); James Armour, Inc., 43 T.C. 295">43 T.C. 295, 43 T.C. 295">307; Commissioner v. Morgan, 288 F.2d 676, 679-680 (C.A. 3), certiorari denied 368 U.S. 836">368 U.S. 836↩.

• 8. As a 50-percent owner of Medco Mfg., Mr. DeGroff was benefitted by Medco Electronics' efforts to market a product which the manufacturing corporation produced. But since the agreement granted Medco Electronics the exclusive right to manufacture the Medco-sonlator, the terms of the license agreement did not assure him of such a benefit.↩

• 9. The only other consideration set forth was the undertaking by Medco Electronics to use its best efforts in the commercial exploitation of the device. But since DeGroff had theoretically parted with all interest in the patent and had reserved no royalty it is difficult to see how this undertaking was of any practical value to him. Of course, he would benefit from the success of the Medco-sonlator as a 50-percent stockholder of Medco Electronics. But it was obviously to the advantage of both DeGroffs as stockholders to exploit the Medco-sonlator through Medco Electronics, and the agreement thus gave Mr. DeGroff nothing of consequence in this connection that he did not already have.↩

• 10. At the trial herein, Mr. DeGroff suggested that he deliberately refrained from making a formal assignment of the right to market the Medco-sonlator because he wanted to remain free to assign rights under the Medco-sonlator patent in the event that differences arose between him and his wife. This explanation strikes us as spurious. The record contains not the slightest suggestion of marital or business differences between the DeGroffs or any anticipation of such differences in the future. Furthermore, if significant difficulties between the DeGroffs had been regarded as a possibility at the time when the Medco-sonlator was transferred to Medco Products, Mrs. DeGroff, a 50-percent stockholder of Medco Electronics, would hardly have been willing to go along with her husband's plan. Moreover, Mr. DeGroff's purported plan could not have achieved its alleged objective in any event. As coowner of Medco Electronics, Mrs. DeGroff, along with her husband, succeeded to whatever rights Medco Electronics had under the license agreement and would have been in a position to halt Mr. DeGroff's independent activities.↩

• 11. We note that in Davant↩ the Court of Appeals decided that (F) was applicable, although the point was not urged in that court by the Government, and this Court carefully avoided passing upon it when the case was here.