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Commissioner of Internal Revenue v. Gilmore's Estate and Six Other Cases .


August 28, 1942


On Petitions for Review of the Decisions of the United States Board of Tax Appeals.

Author: Goodrich

Before BIGGS, MARIS, and GOODRICH, Circuit Judges.

GOODRICH, Circuit Judge.

Under § 112(b)(3) of the Revenue Act of 1934,*fn1 under which this litigation arises, no gain or loss is 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." One of the given definitions of a "reorganization" is a "statutory merger or consolidation".*fn2 This appeal presents two questions: first, whether the transaction, hereinafter described, between a holding company and operating company constituted a "statutory merger or consolidation" and secondly, if it did, whether it was, nevertheless, of such a character that the exchange of stock incident thereto was a taxable event.

The respondents were shareholdrs in the Webster Finance and Investment Company, a New Jersey holding company. They had received their shares from Warren Webster, Sr., who, upon the organization of the holding company in 1927 obtained all its shares for a bare majority of the stock of the operating company, Warren Webster and Company, incorporated in New Jersey in 1895. There is evidence in the record, although no express finding of fact by the Board, that the device of a holding company was chosen by Mr. Webster to insure that the control of the operating company remain in the hands of those active in its management and at the same time enable him to distribute non-controlling beneficial interests, the non-voting stock of the holding company which constituted half of its shares, to the members of his family and employees who at the time did not participate in its mangement or whose future relationship thereto was uncertain.

On October 28, 1935, the directors of the two corporations executed an "Agreement of Merger and Consolidation". The agreement provided that the operating company was to be the surviving corporation. All "rights, privileges, powers and franchises" of the holding company and "all [its] property, * * * except as otherwise provided in Article X" were to vest in the survivor. Under the latter Article, all of the assets, with the exception of the shares of the operating company, were to be distributed as a dividend to the shareholders of the holding company which was to transfer the shares it held in the operating company to the surviving corporation. There was an additional article which enumerated the powers of the surviving company.

After approval by the respective shareholders, the agreement was filed with the Secretary of State of New Jersey. The respondents, in accordance with a provision of the agreement of merger, surrendered their holdign company stock to the surviving corporation and received its shares in return. The holding company stock was thereupon cancelled. The Commissioner asserted that the respondents were taxable upon the gain resulting from this exchange. The Board of Tax Appeals, two members dissenting, did not sustain his position*fn3 and he took this appeal.

Was There a Statutory Merger?

We reject without hesitation the Commissioner's firat argument that there was no merger. Admonished by the argument that we should apply Congressional language in the ordinary sense we think that the term used by Congress "statutory merger or consolidation" means, as Treasury Regulation 86, Art. 112(g)-2 states "a merger or cosolidation effected in pursuance of the corporation lwas of a State or Territory or the District of Columbia." The Commissioner's argument, based upon the dissenting opinion of the Board contends that all of the definitions of the term "merger" require that there be a transfer of property. There was no transfer of property, so it was argued, in the surrender by the holding company to the operating company of the shares of the latter corporation.

One may question whether this argument is now open to the Commissioner. A stipulation between the parties states that the "Agreement of Merger and Consolidation" was approved by the stockholders of the two companies in conformity with the general corporation law of the State of New Jersey and that the appropriate officers of the companies, following the requirements of the New Jersey statute filed the certificates with the appropriate official.*fn4 However, this point need not be stressed to conclusion. Possibly all that was meant to be admitted was that certain of the statutory procedures was in fact followed. The conclusion that there was a statutory merger can stand upon other bases.

The Board's finding of fact states that the officers of the companies followed the requirements of the statutes of New Jersey in filing their documents relative to the merger and that "The filing of those documents effected the merger of the two corporations." The New Jersey statutes provide for a certification by the Secretary of State of a copy of the agreement filed and that such certification "shall be evidence of the existence of such new or consolidated corporation." N.J.S.A. 14:12-3. Such certification is part of the record in this case.*fn5

Furthermore, we can find no provision under the New Jersey Statutes on "Merger or Consolidation", N.J.S.A. 14:12-1 et seq., which makes it a prerequisite to a merger that there be a transfer of property as contended by the Commissioner. Section 14:12-5 does provide that when a merger or consolidation is effected "all the rights, privileges, powers and franchises * * * privileges, powers and franchises * * * all * * * property [etc.] shall vest in the consolidated corporation as effectually as they were vested in the several and respective former corporations." However, this falls far short of saying that if the absorbed corporation owned no property, it could not participate in a merger. Were the Commissioner's contention valid, then it would follow that a "pure" holding company could not become a party to a merger in New Jersey. No statute or decision of that State standing for this proposition has been cited to us; nor have we been able to find any to this effect.

We see no basis on which it can be held that the transaction here questioned was not a merger under the New Jersey statutes and, therefore, not a literal compliance with the Act of Congress within the definitions of the New Jersey statutes and within the definitions of Treasury Regulations construing the Act of Congress.

Was the Merger a Tax Free Transaction?

It is now settled that whether a transaction qualifies as a reorganization under the various Revenue Acts does not turn alone upon compliance with the literal language of the statute. The judicial interpretation has determined that something more may be needed and that, indeed, under some circumstances, something less will do.*fn6 Our concern in this case is the "something more" since we have concluded that there was a literal compliance.

The starting point is Gregory v. Helvering, 1935, 293 U.S. 465, 55 S. Ct. 266, 79 L. Ed. 596, 97 A.L.R. 1355.*fn7 The difference between that case and the one here to be decided is clear. The new corporation was set up for temporary purposes and dissolved when it had a accomplished the purpose for which it was created, namely, to get part of the holdigns of the old corporation into the hands of its shareholders. A distribution in fact was accomplished and the question was whether having made formal compliance with the statute the distribution escaped classification as a taxable event. Despite the petitioner's description of the events in the instant case as devious mechanics we see no such situation in this case as that presented in Gregory v. Helvering.*fn8

The reorganization provisions were enacted to free from the imposition of an income tax purely "paper profits or losses" wherein there is no realization of gain or loss in the business sense but merely the recasting of the same interests in a different form, the tax being postponed to a future date when a more tangible gain or loss is realized.*fn9 This is recognized by the Treasury Regulations.*fn10 They state that: "The purpose of the reorganization provisions * * * is to except from the general rule certain specifically described exchanges * * * which effect only a readjustment of continuing interests in property under modified corporate forms. Requisite to a reorganization under the Act are a continuity of the business enterprise under the modified corporate form, * * * continuity of interest therein on the part of those persons who were the owners of the enterprise prior to the reorganization."

In this case we have two corporations established long before the transaction in question, an operating company and a holding company. They desire to get rid of the holding company. The shareholders of the holding company were the majority owners of the operating company. By reason of the plan chosen they received the shares they had holding company. There was no conversion into cash on withdrawal. Rather, the entire history of the two corporations reveals that the interests obtained through the merger were to be continuing and the surviving corporation kept on doing business with no change in management or personnel after the merger.*fn11 We have, then, a genuine transaction in the sense that it was operating upon the situation of the companies as they stood. We have the continuity of uninterrupted corporate existence of the merged company and the interest of all prior owners therein, except, of course, of the dropping out of the holding company. Are there further requirements?

Argument for the Commissioner maintains that what has been done is still not enough. The result to be reached through this merger, it is said, could have been reached more directly by an out and out liquidation which, of course, would have been taxable under § 115(c).*fn12 Granted that the elimination of the holding company as a subject for taxation was a legitimate business object, it does not follow that the method taken in getting rid of it is a tax-free method.*fn13 We think this gets down to the proposition that if there are two ways of accomplishing a legitimate business result, one of which clearly creates a taxable transaction, one is equally subject to tax liability if he chooses the other unless there is an adequate business reason for the particular method used. We do not think this is the rule of the statute, the Regulations, nor, as we read them, the decisions.*fn14 The cases cited by the appellant do not extend the Gregory doctrine this far. In each of them, that which was attempted to be accomplished in a tax-free manner was not within the spirit and purpose of the reorganization provisions.*fn15 On the other hand, in a recent case, the Supreme Court employed the Gregory principle to bring within the reorganization provisions a transaction which technically could have been excluded where basically there was present a continuity of interest but in a different form so that the transaction was within the spirit of the exemption provision.*fn16 These authorities, we believe, support a negative answer to the question posed.Both parties have cited a group of cases arising out of the reorganization of the General Baking Company.*fn17 While what transpired there as a result of the reorganization of the parent and subsidiary corporations was far more complicated, we find that the principle which withdrew them from the condemnation of Gregory v. Helvering underlies also the present case.*fn18 As was said in one of those cases,*fn19 the fact of there being a merger of a holding company with an operating company does not deny it the exemption provided by the Act.

Our conclusion is that what took place between these companies was a "reorganization in reality", to use the language of the court in the Gregory case, and that it complies with the statutes and the decisions under it.

The decisions of the Board of Tax Appeals are affirmed.

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