McLaughlin, Smith, and Freedman, Circuit Judges.
Petitioner attacks the Tax Court's disallowance of net operating loss carryover deductions on losses which it incurred prior to a reorganization.
The Ix family, through a number of corporations, was engaged in the manufacture and sale of woven synthetic fibers. Separate corporations operated separate mills which manufactured the same types and styles of cloth within the multi-corporation structure. A central office was maintained for accounting, bookkeeping, inventory control and yarn purchasing. There was also provided a central sales force as well as complete technical and production and control staffs. Orders were solicited and returned to a central office in New York where the production and control department determined on the basis of work load and availability of skilled operators which corporation would manufacture the cloth.
In 1952 Frank Ix & Sons, Inc., borrowed $3,000,000 from a bank to make loans to a number of Ix family corporations. To secure the bank indebtedness it pledged as collateral all the capital stock which it owned in the other Ix family corporations and the promissory notes which it received from them for their participation in the loan. One of the conditions of the bank's loan was the maintenance in specified amounts of the working capital of the family corporations.
One of the Ix family corporations operated a mill in Cornelius, North Carolina. Because of the similarity in names of the various Ix corporations and the change in the corporate name of the petitioner, we shall refer to this entity as "Cornelius Ix." Cornelius Ix received $2,550,000 from Frank Ix & Sons, Inc., the major share of the bank loan. In accordance with the bank's requirement, Cornelius Ix agreed that it would maintain its working capital in the amount of $2,800,000. More than a year and a half later, when Cornelius Ix's working capital had fallen nearly a million dollars below the stipulated requirement, a plan of reorganization was adopted with the bank's approval by which there were transferred to Cornelius Ix all of the assets of another Ix family corporation which operated a mill in Charlottesville, Virginia, and which we shall for convenience refer to as "Charlottesville Ix." Both corporations were engaged in the manufacture and sale of woven synthetic fibers, and their common stock was owned in the same proportions by Ix family members. Pursuant to the plan of reorganization Charlottesville Ix transferred all its assets to Cornelius Ix, in return for which Charlottesville Ix received new common stock of Cornelius Ix on the basis of thirteen shares of Cornelius Ix for each outstanding share of Charlottesville Ix. Charlottesville Ix then distributed these shares to its stockholders in complete liquidation and was dissolved. The plan of reorganization was fully consummated on September 30, 1953, and Cornelius Ix changed its name to Frank Ix & Sons Virginia Corporation, the petitioner. It is conceded that the transaction constituted a valid tax-free "D reorganization" under § 112(g)(1)(D) of the Internal Revenue Code of 1939. After the reorganization the same persons held the common stock in the new corporation in the same proportions as their pre-reorganization holdings in Cornelius Ix and Charlottesville Ix.
Cornelius Ix had operated its mill at a loss before the reorganization for the years ending March 31, 1952 and March 31, 1953. After the reorganization, petitioner operated both the mill in Cornelius, North Carolina and the mill in Charlottesville, Virginia, maintaining separate records for each of them, until July 22, 1954, when it shut down the North Carolina mill, which had continued to operate at a loss. The Charlottesville, Virginia mill had realized taxable net income in the years prior to the reorganization and continued to operate at a profit thereafter. For the year ending March 31, 1954, the first fiscal year after the reorganization, petitioner showed a net loss from the operation of the Cornelius mill for the period from September 30, 1953 to the end of the fiscal year, and sustained a net operating loss for the full fiscal year.
What is before us now is the determination by the Commissioner of deficiencies resulting from petitioner's deduction on its 1957, 1958 and 1959 income tax returns of net operating losses sustained by Cornelius Ix for the fiscal year ending March 31, 1953,*fn1 and by Cornelius Ix and petitioner for the fiscal year ending March 31, 1954. The action of the Commissioner was upheld by the Tax Court on the ground that the deductibility of the net operating loss carryovers was determined by the 1939 Code, under which the deduction was barred by the doctrine of Libson Shops, Inc. v. Koehler, 353 U.S. 382, 77 S. Ct. 990, 1 L. Ed. 2d 924 (1957). Frank Ix & Sons Virginia Corporation (N.J.) v. C.I.R., 45 T.C. 533 (1966).
In the Tax Court petitioner's argument for the deductions rested on two grounds. One was that the Libson Shops doctrine was inapplicable to the transaction because Cornelius Ix, which acquired the assets of Charlottesville Ix, was a loss corporation, which made the situation radically different from that with which the Libson Shops doctrine dealt. The second contention was that in any event the "continuity of business enterprise" requirement of the Libson Shops doctrine had been met.
These two contentions lead us back to the Libson Shops case, which the Supreme Court decided in 1957 under the 1939 Code. There a number of individuals directly or indirectly owned in the same proportions the stock of seventeen corporations. One of the corporations provided management services for the remaining sixteen corporations, each one of which, separately operated, was engaged in the retail sale of women's apparel. Each corporation filed a separate income tax return. In a tax-free reorganization the sixteen operating corporations, three of which had been sustaining losses and thirteen of which had been profitable, were merged into the management corporation. The Commissioner disallowed the deduction by the surviving corporation from its net income derived from the thirteen profitable units of the losses carried over from former years of the three unprofitable corporations. The Supreme Court found it unnecessary to decide the Commissioner's primary contention that the surviving corporation was not the same "taxpayer" as that which had sustained the losses in the prior years.*fn2 Instead the Court disallowed the deduction on the ground that the losses, and the profits from which they were sought to be deducted, were not produced by "substantially the same businesses." The Court thus chose to decide the case on the basis of economic substance rather than on the more technical question whether the surviving corporation was the same "taxpayer" as the constituent units which had sustained the losses.
The Libson Shops case has given rise to a flood of discussion and much dispute regarding its application in particular circumstances.*fn3 The facts in the present case however, fall so remarkably close to the circumstances which existed in Libson Shops and we therefore stand so close to the center of the doctrine that there is no need to consider its application in the more remote areas in which its repercussions may be felt. The decisive fact in Libson Shops was that a number of individuals had chosen to cast their investment into seventeen separate corporations and thus to spread the risk of their undertaking among separate business units and to enjoy the benefits of separate incorporation and separate tax returns for each of them. Thus, by their own choice they made each corporation a separate business unit as well as a separate taxpayer. The Court therefore determined that they could not disregard this choice in order to enjoy the deduction of a net operating loss carryover of one taxpayer-business unit from the profits of another, separate taxpayer-business unit by a formal act of corporate merger. The court believed that such a deduction was forbidden by the policy underlying the allowance of net operating loss carryovers, which was to protect a single business from the hazards of fluctuating income. The establishment of the seventeen separate business units was a choice in the opposite direction; within each individual unit the loss carryover provision applied, but the investors could not enjoy that benefit and also reap the contradictory advantage, by merger, of enjoying the loss carryover advantage beyond the boundaries of the individual unit.
In the present case, as in Libson Shops, individuals chose to cast their investment into separate corporate units, each of which was a separate economic entity as well as a separate legal entity, and the assets which produced the income against which earlier losses were sought to be applied were different from the assets which produced the losses. If the separate businesses had not been combined there would have been no right to utilize the net operating loss carryover from the unprofitable corporation to reduce the taxable income of the profitable corporation. Whatever differences exist between the factual circumstances in the present case and in Libson Shops are not of decisive significance. The fact that what occurred here was not an "A reorganization", a statutory merger, but instead a "D reorganization", a transfer of assets for stock, is a factual difference without any legal distinction. The policy of Libson Shops, where indeed there was a retention of one hundred per cent control, cannot be diminished because the "D reorganization" involved here was subject to a statutory requirement of eighty per cent retention of control of the transferee corporation by the owners of the transferor corporation.
Petitioner earnestly contends that the fact that here the loss corporation acquired in reorganization the assets of the profitable corporation significantly distinguishes this case from Libson Shops, where the central service corporation absorbed by merger the ...