DocketNumber: Docket No. 83836
Citation Numbers: 38 T.C. 773, 1962 U.S. Tax Ct. LEXIS 86
Judges: Pierce
Filed Date: 8/30/1962
Status: Precedential
Modified Date: 10/19/2024
Petitioner corporation, during the years 1952 and 1953, experienced substantial changes in its stockownership and in the character of its business -- as the result of a chapter X bankruptcy reorganization. the discontinuance of its former business, and the taking over of a new type of business theretofore operated by another corporation. Prior to its reorganization it had engaged in the business of manufacturing candy and operating a chain of restaurants; and after such reorganization, it engaged in the business of manufacturing aluminum and other metal products.
38 T.C. 773">*774 Respondent determined deficiencies in the petitioner's income taxes for its fiscal years ended June 30, 1956 and 1957, in the amounts of $ 37,500 and $ 640,386.77, respectively.
The issues for decision are:
(1) Whether a corporation which had in 1952 and 1953 experienced substantial changes in its stockownership and in the character of its business -- as the result of a chapter X bankruptcy reorganization, the discontinuance of its former business, and the taking over of a new type of business theretofore operated by another corporation -- may, under
(2) Whether said corporation may carry over and deduct in a taxable year following its reorganization, a capital loss sustained in a year prior to said reorganization.
The only other issue 1962 U.S. Tax Ct. LEXIS 86">*88 raised by the pleadings (pertaining to the effect of a net operating loss sustained in the postreorganization period) is dependent on the decision of Issue 1; and any proper adjustment with respect thereto will hereinafter be made in the computation under Rule 50.
FINDINGS OF FACT.
Most of the facts have been stipulated. The written and oral stipulations of facts, including all exhibits therein identified, are incorporated herein by reference.
The petitioner, Huyler's, is a New York corporation which had its principal office and place of business in Indianapolis, Indiana. Its income tax return for each of the taxable years involved was filed with the district director of internal revenue at Indianapolis.
The corporate charter of Huyler's, which has from time to time been extensively amended and restated, was originally issued by the State of New York in 1881. The corporation's business for a period of about 70 years following its incorporation, until about 1953, was that of manufacturing candy and operating a chain of restaurants. 38 T.C. 773">*775 In 1948, it and its subsidiaries had candy factories with a total capacity of 21,500,000 pounds of candy per year; and it also had 23 restaurants located 1962 U.S. Tax Ct. LEXIS 86">*89 in New York City and other cities in the eastern and midwestern sections of the United States.
Early in the year 1951, Huyler's experienced critical financial difficulties, due principally to failure to dispose of large inventories of candy which had been built up in anticipation of the preceding Christmas season. Following unsuccessful efforts to obtain additional working capital, it in April 1951 filed a voluntary petition in the United States District Court for the Southern District of New York, for an arrangement with creditors under chapter XI of the Bankruptcy Act. The debtor, Huyler's, was allowed to remain in possession of its business until September 1951, at which time a receiver was appointed. Then, on February 25, 1952, the chapter XI proceeding was dismissed, and the assets in the hands of the receiver were returned to the corporation. During the pendency of this chapter XI proceeding, all of Huyler's candy factories were sold; and Huyler's at no time thereafter engaged in the manufacture of candy. Also during the pendency of said court proceeding, certain of Huyler's restaurants were closed; so that at the end of said court proceeding, its only business was that of 1962 U.S. Tax Ct. LEXIS 86">*90 operating 11 remaining restaurants. In addition, during the pendency of said court proceeding, the receiver issued certain receiver's certificates for the purpose of obtaining cash for administration expenses; and these certificates constituted a first lien on all the properties of Huyler's.
On April 23, 1952, which was only about 2 months after the dismissal of the chapter XI proceeding, Huyler's filed another voluntary petition in the same District Court -- this second petition being for a reorganization under chapter X of the Bankruptcy Act. Thereupon, the court appointed a trustee to take over and administer the business.
While the chapter X proceeding was pending, the trustee gave consideration to several plans for reorganization of the business, which had been submitted to him by various groups. He finally selected one of these plans which he presented to the court as a proposed plan of reorganization. This proposed plan was subsequently amended; was then, in its amended form, approved by the court and the other necessary parties in interest; and was put into effect on or about December 1, 1952. A summary of the principal effects of the adoption of this plan is as follows:
1. 1962 U.S. Tax Ct. LEXIS 86">*91 The charter of Huyler's, which as before stated had originally been issued in 1881, was extensively amended and restated; and the charter, as so revised, was continued in force for the reorganized business.
38 T.C. 773">*776 2. The interests of the holders of all of Huyler's previously issued and outstanding stock (consisting of 42,485 shares of first preferred stock; 29,000 shares of second preferred stock; and 700,000 shares of common stock -- all having par value of $ 1 per share) were eliminated.
3. $ 250,000 of new capital was paid into the corporation, in cash, by three individuals (hereinafter called the "new interests"), in exchange for shares of new common stock and new debentures hereinafter mentioned.
4. New common stock, consisting of 100,000 shares of the par value of $ 1 each, was issued as follows:
(a) 48,000 shares (48 percent) to the "new interests," in partial consideration for their above-mentioned investment of new capital; and
(b) 52,000 shares (52 percent) to nominees for certain creditors, in whole or partial satisfaction of their claims.
5. $ 250,000 of new 5-percent debentures due December 31, 1955, were issued to the "new interests," in further partial consideration for their said 1962 U.S. Tax Ct. LEXIS 86">*92 capital investment.
6. About $ 360,000 of new 6-percent subordinated debentures due December 1, 1957, were issued, in part to the United States Government and certain States and localities in satisfaction of their claims for unpaid taxes, and in part to certain nongovernmental creditors in satisfaction of their claims.
7. All of Huyler's right, title, and interest in 4 of its 9 remaining restaurants (the trustee having disposed of 2 of the 11 restaurants which Huyler's had in operation at the inception of the chapter X proceeding) were assigned to a nominee of an individual creditor in partial satisfaction of his claims.
8. A restaurant-operating agreement was entered into by the reorganized Huyler's with a restaurant management corporation, under which the latter agreed to operate for a period of 2 years, the only five remaining restaurants which had not theretofore been disposed of.
9. Nine new directors were selected, of which six were named by the "new interests"; and also five new officers were selected, of which the president, two vice presidents and the secretary were from among the new directors selected by the "new interests."
Upon consummation of the above plan of reorganization 1962 U.S. Tax Ct. LEXIS 86">*93 in December 1952, title to all assets held by the trustee was vested in the reorganized Huyler's. The only remaining operating assets which Huyler's then had, were the five restaurants that were being operated for it by the above-mentioned restaurant management company. 38 T.C. 773">*777 These restaurants proved unprofitable however; and as a consequence, they were closed as follows: One restaurant was closed on December 31, 1952; three during 1953, and the last one on September 15, 1954. Huyler's never thereafter operated any restaurant.
On or about March 13, 1953, Huyler's bought all the issued and outstanding shares of capital stock of Basca Manufacturing Company, Inc., an Indiana corporation that is hereinafter more fully described. The purchase price of the Basca stock was $ 2,600,000 of which $ 240,000 was paid in cash at the closing; and the balance was to be paid over a period of about 10 years, through contract installments secured by specified liens and mortgages. The reason for purchasing this stock was that the stockholders of Basca refused to allow a sale of its assets; and therefore, Huyler's purchased the stock as a means for obtaining the assets. Immediately after the purchase 1962 U.S. Tax Ct. LEXIS 86">*94 of said stock, Huyler's completely liquidated the Basca company, took over its business, and dissolved that corporation. At the time of such acquisition of the Basca business, Gerald L. Canfield, who had been the majority stockholder and president of Basca, was employed as vice president of Huyler's to manage the former Basca business.
Basca, as before stated, was an Indiana corporation. It had been organized in 1934, and it had its principal place of business in Indianapolis. For about 12 years following its organization, its business had been that of manufacturing automobile mufflers and automotive replacement parts; but at the time it was taken over by Huyler's, it was engaged in manufacturing various aluminum products, and also shell projectiles under a contract with the United States Government. Basca's financial statement for the year ended December 31, 1952, showed net sales of over $ 5 million; net profits (exclusive of $ 70,000 of refundable Federal taxes) of approximately $ 67,300; and net assets per books of over $ 700,000. Its only outstanding shares of capital stock were 86 shares of common stock -- of which 80 1/2 shares were held by its president, Gerald L. Canfield, 1962 U.S. Tax Ct. LEXIS 86">*95 and of which the remaining shares were held by Canfield's sister and his attorney. As before stated, all of this stock, and shortly thereafter all of the going business of Basca, were taken over by Huyler's.
Subsequently on August 31, 1954, the "new interests" surrendered to Huyler's, in advanced redemption at par, all of their $ 250,000 of 5-percent debentures due December 31, 1955, which they had acquired from Huyler's in the reorganization. Also, in May and August 1954, the "new interests" sold for an aggregate price of $ 315,000, all of their 48 shares of Huyler's common stock which they likewise had acquired in the reorganization. Of said stock, 24,000 shares were sold to Canfield (who as before said, had been the majority stockholder and president of Basca) and to members of his family; and 24,000 38 T.C. 773">*778 shares were sold to Millard H. Pryor (who had been a director of Basca) and to members of his family and two trusts for his children. The results of all this disposition of debentures and stock by the "new interests" were, that said "new interests" received an aggregate of $ 565,000 for the $ 250,000 investment of new capital which they had paid in at the time of the reorganization; 1962 U.S. Tax Ct. LEXIS 86">*96 and that they thereupon ceased to have any financial interest in Huyler's.
In the fall of 1954, eight new directors were elected for Huyler's; and the above-mentioned Millard Pryor became the new president. Later, in 1957, Canfield replaced Pryor as president of Huyler's; and the latter then became chairman of the board of directors.
Huyler's, upon its acquisition of the going business of Basca, moved its principal office to Indianapolis, where the Basca manufacturing plant was located. Thereafter, its principal activities were as follows. For a period of about 18 months while its five remaining restaurants were being liquidated in the manner above described, it operated the Basca business as a division. Following such liquidation, its sole activity was the operation of Basca's former business from the Indiana plant. The principal products produced in its operation of the former Basca business were aluminum foil milk bottle caps, aluminum drinking cups, and artillery shells manufactured for the United States Government under the contract taken over from the Basca company. In June 1956, Huyler's completed its work on said Government shell contract; and at about the same time, it 1962 U.S. Tax Ct. LEXIS 86">*97 bought all of the capital stock of an Indiana corporation named Twigg Industries, Inc., which was engaged in manufacturing component parts for the aircraft industry. Shortly thereafter in August 1956, it likewise liquidated Twigg, took over its business, and dissolved that corporation. During the taxable years here involved, the manufacture of metal products continued to be Huyler's sole activity.
A summary of Huyler's profits and net operating losses for its fiscal years ended June 30, 1951 through 1955 (the amounts of which have been stipulated), is as follows:
Restaurant and | Basca division | |
Fiscal year ended June 30 -- | candy operations | operations |
1951 | ($ 1,272,770.86) | |
1952 | (1,574,801.80) | |
1953 | (909,719.25) | $ 324,823.77 |
1954 | 298,568.19 | |
1955 | (333,471.25) |
The amounts of net income which Huyler's derived from its metal-manufacturing business for the fiscal years ended June 30, 1956 and 1957, as reported on its Federal income tax returns for said years 38 T.C. 773">*779 (before any adjustment for claimed net operating loss carryovers), were $ 127,946.31 and $ 1,480,976.67, respectively.
On Huyler's income tax returns for its fiscal years 1956 and 1957, it claimed deductions for net operating loss carryovers from the 1962 U.S. Tax Ct. LEXIS 86">*98 years 1951, 1952, and 1953 -- which net operating losses had been sustained in the carrying on of its former business of manufacturing candy and operating a chain of restaurants. Also, in its 1956 return it claimed a deduction for a capital loss carryover of $ 4,893.94 from its fiscal years 1952 and 1953, which it had sustained from the sale of the stock of one of its former candy factories.
The respondent, in his statutory notice of deficiency for the fiscal years 1956 and 1957 here involved, disallowed said claimed deductions for net operating loss carryovers; and he also disallowed the claimed deduction for capital loss carryovers. His explanation for said disallowances was as follows:
(A) It is determined that the amounts * * * claimed as net operating loss deductions on your income tax returns for the fiscal years ended June 30, 1956 and June 30, 1957, are not allowable deductions under the provisions of (a) You are not the same taxpayer within the meaning of * * * *
(b) It is determined that the amount of $ 4,893.94 claimed as a short-term capital loss on your income tax return for the taxable year ended June 30, 1956 is not an allowable deduction because you are not the same taxpayer within the meaning of
OPINION.
The first issue for decision is this: Can the petitioner corporation carry over and deduct from its "postreorganization" income for the years 1956 and 1957, which it derived from the operation of a metal-fabricating business, certain net operating losses which 1962 U.S. Tax Ct. LEXIS 86">*100 it had sustained during its "prereorganization" years of 1951, 1952, and 1953, while it was engaged in a former business of manufacturing candy and operating a chain of restaurants?
38 T.C. 773">*780 1. Statutory provisions for the carrying forward and carrying back of net operating losses have, since the Revenue Act of 1918, been part of our Federal income tax system. The basic policy of such provisions has been to make available a method for "evening out" the peaks and troughs of the profit curve of a business having fluctuating gains and losses, under our system of annual accounting for income tax purposes. But over the years, the Congress, the courts, and the Internal Revenue Service have raised barriers to the use of such method, in various situations where its use was thought to be inconsistent with the policy underlying the loss carryback and carryover deductions.
Subsequently, this entity concept was applied with increased emphasis by this Court, in the case of
The above-mentioned "entity concept" appeared to remain inviolate until the decision of the Second Circuit in
The result of these earlier cases was to create uncertainty in the application of the statutory provisions relating to net operating loss carryovers, so that neither the Government nor taxpayers could accurately predict the consequences of corporate changes. Survival of tax attributes appeared to depend primarily on the form of the transactions, and on the technical skill with which they were effected. Thus the "entity concept" theory tended to penalize taxpayers who were either poorly advised or who, for nontax reasons, 1962 U.S. Tax Ct. LEXIS 86">*104 found it necessary to extinguish the loss entity.
During this same period when the above cases were being litigated, Congress took note of the "trafficking" which was being carried on with respect to loss corporations, i.e.: The practice under which loss corporations were in many instances being bought up, primarily for the purpose of obtaining the benefit of their loss history for income and excess profits tax purposes. Accordingly, Congress in 1943 added a new section to the 1939 Code, section 129, which in substance prohibited the allowance of deductions to a successor corporation, in situations where control of another corporation had been acquired for the primary purpose of obtaining that corporation's losses for tax purposes. This legislative attempt to meet the situation did not, however, prove to be effectual. See S. Rept. No. 1622, 83d Cong., 2d Sess., p. 53.
It was against the background of the foregoing decisions and legislative actions that the Supreme Court in 1957 reentered the area with 38 T.C. 773">*782 its decision in the
2. The requirement of a continuity of business enterprise as applied to this case is in accord with the legislative history of the carry-over and carry-back provisions. Those provisions were enacted to ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. They 1962 U.S. Tax Ct. LEXIS 86">*106 were designed to permit a taxpayer to set off its lean years against its lush years, and to strike something like an average taxable income computed over a period longer than one year. * * * What [legislative] history there is suggests that Congress primarily was concerned with the fluctuating income of a single business. * * * * * * * The availability of this privilege [of deducting carryover losses] depends on the proper interpretation to be given to the carry-over provisions. * * * We conclude that petitioner is not entitled to a carry-over since the income against which the offset is claimed was not produced by substantially the same businesses which incurred the losses. [Footnotes omitted.]
It is true that in the
In the
True it is that the factual situation in
* * * *
Nevertheless, we think the Supreme Court in
* * * *
If we apply the reasoning of the Supreme Court in
The Court of Appeals for the Fourth Circuit, in affirming our above decision in the
It is fantastic to suppose that Congress, in carrying out its purpose to lighten the burdens of the taxpayer incident to the annual accounting system by offsetting losses of bad years against profits of good years, should have intended to permit a corporate taxpayer under new ownership to offset the losses of an earlier unsuccessful enterprise against the gains of a totally different enterprise 1962 U.S. Tax Ct. LEXIS 86">*109 subsequently undertaken. * * *
In the
we think
The basis of the Court's decision is directly applicable to this case and we think leaves no doubt of what it meant. Mr. Justice Burton, for the Court, pointed out that the government was contending "that the carry-over privilege is not available unless there is a continuity of business enterprise." * * * Then the opinion goes on to say that this requirement of continuity of business enterprise accords "with the legislative history of the carry-over and carry-back provisions." The Court cites the legislative history pointing out that the provisions were enacted to "ameliorate the unduly drastic consequences of taxing income strictly on an annual basis. They were designed to permit a taxpayer to set off its lean years against its lush years and to strike something like an average taxable income computed over a period longer than one year." * * * That case is a stronger 1962 U.S. Tax Ct. LEXIS 86">*110 case for the taxpayer than the one before us. The shareholders remained the same 38 T.C. 773">*784 in these various Libson corporations. The same business was carried on after the merger as before. * * *
Since the Supreme Court said that was insufficient for the application of
The decisions of the Fifth Circuit in
3. As regards the present case, we think that the decision in
The petitioner has suggested that the "special limitations" of
The second issue for decision is whether the petitioner corporation is entitled to carry over and deduct from its postreorganization income of the year 1956, a
The petitioner did not, on brief, separately develop this point; and the respondent, on brief, took the position that the decision of the first issue (relating to the carryover of
Moreover, in
We decide this second issue also in favor of the respondent.
1. See review of the history and development of the carryback and carryover provisions in 69 Yale L. Jn. 1201 (1960).↩
2. At the trial herein, we granted an unopposed motion of the petitioner, which had the effect of excusing it from then presenting proof of facts relative to changes in the ownership of its stock occurring after June 22, 1954, which would be pertinent if the above-mentioned
Helvering v. Metropolitan Edison Co. , 59 S. Ct. 634 ( 1939 )
Libson Shops, Inc., v. Koehler, District Director of ... , 77 S. Ct. 990 ( 1957 )
A. C. Willingham v. United States , 289 F.2d 283 ( 1961 )
Commissioner of Internal Revenue v. Virginia Metal Products,... , 290 F.2d 675 ( 1961 )
Stanton Brewery v. Commissioner of Internal Revenue , 176 F.2d 573 ( 1949 )
Patten Fine Papers, Inc. v. Commissioner of Internal Revenue , 249 F.2d 776 ( 1957 )
Mill Ridge Coal Company v. George D. Patterson, District ... , 264 F.2d 713 ( 1959 )