APPEAL FROM THE UNITED STATES TAX COURT (T.C. Nos. 4953-74, 6153-74, 6187-74, & 8602-74) APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF DELAWARE (D.C. Civil No. 75-0218)
Before Aldisert, Weis and Higginbotham, Circuit Judges.
The major issue presented by these consolidated appeals from the United States Tax Court and the United States District Court for the District of Delaware is whether the use of consideration other than voting stock is allowable in a tax deferred stock for stock reorganization as defined in § 368(a)(1)(B) of the Internal Revenue Code, 26 U.S.C. § 368(a)(1)(B). In the vernacular, the question is whether "boot" may be used in a clause B corporate reorganization. Both courts below agreed with the taxpayers that other consideration is allowable so long as "control" of the target corporation is obtained "solely for . . . voting stock," and thus allowed them to defer recognition of their gain under § 354(a)(1), 26 U.S.C. § 354(a)(1). We hold that, in a stock for stock transaction in which control is achieved, the acquiring corporation may exchange no consideration other than voting stock to effect a tax deferred clause B reorganization. We therefore reverse.
The facts have been detailed in the trial court opinions, Reeves v. Commissioner, 71 T.C. 727, 728-31 (1979), and Pierson v. United States, 472 F. Supp. 957, 958-60 (D.Del.1979), so we need not elaborate them at length. The transaction at issue involved the acquisition of stock in Hartford Insurance Company by International Telephone and Telegraph Corporation. ITT first made overtures to the management of Hartford in 1968, suggesting either an acquisition of Hartford by ITT or merger of Hartford into ITT. Hartford rejected these immediate proposals, but apparently gave no definitive veto to a future amalgamation. ITT subsequently purchased for cash, in two block transactions and various open market transactions, approximately eight percent of Hartford's outstanding stock.
In December 1968, ITT proposed merger terms to Hartford, leading to a provisional agreement on April 9, 1969, to merge Hartford into a wholly owned subsidiary of ITT. The Antitrust Division of the Department of Justice commenced litigation to enjoin the merger in August 1969, but its motion for preliminary injunction was denied in October 1969. On October 13, 1969, the Internal Revenue Service issued a private letter ruling advising ITT and Hartford that the proposed merger would be within § 368(a)(1)(B) if ITT unconditionally divested itself of the Hartford stock it had previously purchased for cash. On October 21, the IRS ruled that ITT's proposed sale of the stock to Mediobanca, an Italian bank, would constitute an unconditional disposition, and ITT consummated the sale.
Although ITT overcame the obstacles erected by the Antitrust Division and the IRS, and obtained approval for the transaction from the Hartford and ITT shareholders, the merger fell through when the Connecticut Insurance Commissioner withheld his approval. ITT and Hartford then proposed an offer to the Hartford shareholders of ITT stock for their Hartford stock. The Connecticut Insurance Commissioner ultimately approved this plan, and ITT submitted the exchange offer to the Hartford shareholders on May 26, 1970. By June 8, 1970, over ninety-five percent of the Hartford shares, including those held by Mediobanca, had been tendered.
In March 1974, the IRS, alleging misrepresentations in ITT's application for the private letter ruling regarding the sale of Hartford stock to Mediobanca, retroactively revoked its ruling that deemed that sale an unconditional disposition of the stock. The effect of the revocation, according to the IRS, was to disqualify the transaction from treatment under clause B and thus to preclude tax deferral of the gain realized by the Hartford shareholders when they exchanged their Hartford stock for ITT stock. The Service reasoned that clause B allows no consideration other than voting stock, and that the purchase for cash of eight percent of Hartford stock by ITT precluded treatment of the transaction under clause B. As a result, the Service assessed tax deficiencies against the former Hartford shareholders, including the appellees here.*fn1
In the trial courts, taxpayers sought deferral of their gain under § 354(a) of the Internal Revenue Code, 26 U.S.C. § 354(a), arguing that they participated in a corporate reorganization. They rely on § 368(a)(1)(B), which defines "reorganization" as an acquisition, solely for voting stock, of stock of another corporation, if the acquiring corporation is in "control" of the other corporation immediately after the exchange.
The two courts below granted taxpayers' motion for summary judgment, though on somewhat different grounds. Before both courts, taxpayers asserted alternative grounds for summary judgment. They argued initially that the cash purchases of stock by ITT in 1968 were not part of the same "plan of reorganization" as its acquisition of ninety-five percent of Hartford's stock in 1970. The requirement that the exchange be "solely for voting stock" was thus fulfilled because the prior cash purchases should not be considered. Their alternative argument was that even if the cash purchases were part of the plan of reorganization, they constituted a separate "transaction" from the exchange of stock for stock. Under their interpretation, clause B requires only the acquisition of "control" of the target corporation "solely for . . . voting stock" of the acquiring corporation. Thus, ITT's acquisition was within clause B because the stock transaction gave it "control" of Hartford. Both courts accepted the second argument and, concluding that it was fully dispositive, declined to address the first argument.
The appeal from the tax court emanates from a case styled Reeves v. Commissioner, 71 T.C. 727 (1979), which held that ITT's acquisition of more than eighty percent of Hartford's stock in a single transaction satisfied the "solely for voting stock" requirement of clause B, regardless of the cash exchanges. Id. at 741-42. In an opinion announcing the decision of the court,*fn2 Judge Tannenwald began his analysis with an observation that the legislative history underlying § 368 is inconclusive on this issue. Id. at 732 (citing Turnbow v. Commissioner, 368 U.S. 337, 344 n.8, 82 S. Ct. 353, 357 n.8, 7 L. Ed. 2d 326 (1961). He distinguished Helvering v. Southwest Consolidated Corp., 315 U.S. 194, 62 S. Ct. 546, 86 L. Ed. 789 (1942), in which the Supreme Court held that an earlier version of the reorganization section dealing with both stock for stock and stock for asset exchanges allowed no consideration other than voting stock, because it involved an asset acquisition, not a stock acquisition. He also noted that Southwest Consolidated addressed a situation in which voting stock represented only sixty-three percent of the total consideration. 71 T.C. at 734-35.
Judge Tannenwald distinguished other decisions by grouping them into two categories. The first category included decisions in which the control requirement could be met only by taking into account prior acquisitions. In this category he grouped Lutkins v. United States, 312 F.2d 803, 160 Ct.Cl. 648, cert. denied, 375 U.S. 825, 84 S. Ct. 65, 11 L. Ed. 2d 57 (1963), Commissioner v. Air Reduction Co., 130 F.2d 145 (2d Cir.), cert. denied, 317 U.S. 681, 63 S. Ct. 201, 87 L. Ed. 546 (1942), and Pulfer v. Commissioner, 43 B.T.A. 677 (1941), aff'd 128 F.2d 742 (6th Cir. 1942) (per curiam). 71 T.C. at 736. The second category of decisions involved single transactions in which more than eighty percent of the target corporation's stock was acquired but both voting stock and other consideration was used in the acquisition. 71 T.C. at 736. Included in this category were Turnbow v. Commissioner, 368 U.S. 337, 82 S. Ct. 353, 7 L. Ed. 2d 326 (1961), Mills v. Commissioner, 39 T.C. 393 (1962), rev'd, 331 F.2d 321 (5th Cir. 1964), and Howard v. Commissioner, 24 T.C. 792 (1955), rev'd on other grounds, 238 F.2d 943 (7th Cir. 1956). More specifically, "(in) Mills and Turnbow, each shareholder whose stock was being acquired got cash." 71 T.C. at 736. In addition, "Howard is factually distinguishable . . . because some stockholders involved in the one exchange transaction . . . received cash." Id. at 737. Judge Tannenwald concluded that neither category should apply to a situation in which ITT obtained "control" of Hartford by giving only ITT shares for Hartford shares in exchanges clearly separable from concurrent cash exchanges.
As support for his conclusion that clause B is undeserving of a "pervasively rigid interpretation," Judge Tannenwald noted that legislative amendments of clause B indicate a continuing congressional concern that courts were interpreting the "solely" requirement too rigidly and that the IRS had issued numerous rulings allowing technical exceptions to that requirement. Id. at 740. He also noted that a strict construction of "solely for . . . voting stock" would create such "odd results" as making some transactions that initially complied with clause B retroactively taxable if additional shares were acquired for nonstock consideration. Id. at 740-41. The court concluded:
We are not unaware of the conceptual difficulties involved in determining what is "the acquisition" for purposes of a (B) reorganization and that an argument can be made that separating out the 1970 exchange begs the question, or to put it another way, assumes the issue which requires decision. But we do not see the situation in this light. The facts of the matter are that the 1970 exchange, standing by itself, satisfied in every way the literal requirements of section 368(a)(1)(B) and that neither legislative nor judicial history nor policy requires that that exchange (involving in excess of 80 percent of Hartford's stock) not be separated from the other acquisitions of Hartford stock by ITT for cash, at least for the purpose of disposing of the legal issue raised by petitioners' second contention. We take this position with full knowledge that, for the purpose of disposing of that contention, on this motion for summary judgment, we must assume that the pre-1970 cash purchases were part of the "plan of reorganization." But our position, simply stated, is that, in the context of this case, such assumption is of no consequence because the prior purchases are irrelevant.
Id. at 741 (footnote omitted).*fn3 Two judges concurred and five judges dissented.*fn4 The Commissioner has appealed the Tax Court decision.*fn5
The district court blazed a somewhat different trail. Judge Schwartz also concluded that prior decisions did not foreclose a result favorable to the taxpayers. He dealt at length with Southwest Consolidated, noting that it was decided under the Revenue Act of 1934, which treated stock acquisitions identically to asset acquisitions. 472 F. Supp. at 962. But subsequent changes in the reorganization statute have, he reasoned, destroyed that decision's precedential value. Id. at 963. The Air Reduction and Howard decisions, emphasizing the identity between stock and asset acquisitions, relied on Southwest Consolidated to disallow consideration other than voting stock in stock acquisitions. Judge Schwartz found Air Reduction unpersuasive because it failed to give a reasoned elaboration for its conclusion. 472 F. Supp. at 962-63. Although Judge Schwartz recognized that the ninth circuit had examined the legislative history of clause B in Turnbow, he noted that the court's inquiry did not determine whether "solely" permits consideration other than voting stock, "but rather was aimed at demonstrating that there was some limitation on the presence of boot." Id. at 965. Similarly, he noted that in Mills v. Commissioner, 331 F.2d 321 (5th Cir. 1964), the fifth circuit addressed an issue other than the "solely" requirement in concluding that cash payments for fractional shares were not "consideration" in the sense prohibited by clause B. 472 F. Supp. at 965. Finally, he disapproved Lutkins v. United States, 312 F.2d 803, 160 Ct.Cl. 648, cert. denied, 375 U.S. 825, 84 S. Ct. 65, 11 L. Ed. 2d 57 (1963), because it relied entirely on Southwest Consolidated and Howard as the rationale for disallowing cash in a stock for stock exchange. 472 F. Supp. at 965-66. He interpreted the Supreme Court's decision in Turnbow as expressly reserving the issue. Id. at 966.
After concluding that no prior decisions were of precedential value, Judge Schwartz analyzed the legislative history of clause B. He noted that the ninth circuit's analysis of the legislative history in Turnbow hinged on its assumption that the amendment to clause C allowing some nonstock consideration in asset acquisitions necessarily implied an intent not to allow other consideration in stock acquisitions. He rejected this assumption, however, because Congress may have been unaware of a settled judicial interpretation of clause B when it amended clause C. Instead of relying on specific citations to the legislative history, he relied on the "principal policy underlying the statutory scheme that of facilitating corporate reorganizations," and noted that allowing some consideration other than voting stock in clause B reorganizations would be advantageous in effecting reorganizations. Id. at 973. He also analogized clause B to clause C, noting that "(if) Congress was content to permit up to twenty percent boot in a (C) reorganization, it must be assumed a fortiori that an equivalent amount of boot was permissible in a (B) reorganization, absent a clear rule to the contrary of which Congress must have been aware." Id. at 973 (footnote omitted). Finally Judge Schwartz reasoned that allowing consideration other than voting stock under clause B would, in view of the "creeping control" amendment to clause B in the 1954 Code, create a "well-ordered universe" in the reorganization sections of the Internal Revenue Code. Id. at 974 (quoting Merritt, Tax-Free Corporate Acquisitions The Law and the Proposed Regulations, 53 Mich.L.Rev. 911, 933 (1955)). These considerations, he concluded, dictated a construction of clause B that allows up to twenty percent nonstock consideration so long as the acquiring corporation acquires at least eighty percent of the target corporation's stock solely for its own voting stock.
After a detailed review of prior decisions, the legislative history, and the policies underlying the reorganization section, we conclude that the interpretation urged by the Commissioner is essentially correct. At the outset, we emphasize the burden the taxpayers must shoulder in overturning a construction of the statute that has prevailed in both judicial opinions and tax planning for almost fifty years. Were we clearly convinced that this prevailing interpretation is incorrect, we would not hesitate to adopt the construction advocated by the taxpayers. But their argument, under close examination, implicitly assumes that the prevailing statutory construction is so irrational that the Commissioner must affirmatively justify it. Not only do we disagree with the assumption that disallowing nonstock consideration under clause B is irrational, but we note that the taxpayers have subtly attempted to shift their burden of overturning a settled construction of the statute back to the Commissioner. Quite apart from the reasons below, which indicate that consideration other than voting stock has no place in stock for stock acquisitions, we fundamentally disagree with taxpayers' implicit assumption that the settled construction of the statute, in an area in which stability is of considerable importance, should be accorded little or no deference.
Because this case presents an issue of statutory construction, "the "starting point' must be the language of the statute itself." Lewis v. United States, 445 U.S. 55, 100 S. Ct. 915, 918, 63 L. Ed. 2d 198 (1980) (citations omitted); see also United States v. DiSantillo, 615 F.2d 128 at 134 (3d Cir. 1980). Under the statutory schema, the general rule is that any gain*fn6 on the sale or exchange of property must be recognized. At the time of the transactions under consideration here, this rule appeared in § 1002 of the Internal Revenue Code, 26 U.S.C. § 1002: "Except as otherwise provided in this subtitle, on the sale or exchange of property the entire amount of the gain or loss, determined under section 1001, shall be recognized." Taxpayers argue that their exchanges are within an explicit exception to § 1002. however, because § 354(a) of the Code provides that "(no) gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of a plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization." If a valid reorganization occurs, any consideration other than stock or securities received by shareholders is subject to recognition in the amount of the gain realized, but the gain recognized will not exceed the amount of nonstock consideration received. § 356(a) of the Internal Revenue Code, 26 U.S.C. § 356(a). See Turnbow v. Commissioner, 368 U.S. 337, 344, 82 S. Ct. 353, 357, 7 L. Ed. 2d 326 (1961).
The linchpin of taxpayers' argument, therefore, is that the acquisition of Hartford stock by ITT was a valid reorganization as defined in § 368(a)(1) of the Code, 26 U.S.C. § 368(a)(1). Specifically, they rely on clause B, which defines a reorganization as
the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not such acquiring corporation had control immediately before the acquisition) . . . .
§ 368(a)(1)(B) of the Internal Revenue Code, 26 U.S.C. § 368(a)(1)(B). The section defines "control" as "the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation." Id. at § 368(c). The parties agree that ITT obtained the requisite amount of Hartford stock to achieve "control" under this definition. They also agree that if the transaction satisfies clause B, the taxpayers received stock from a "party to a reorganization" in exchange for their stock in a "party to a reorganization." See id. at § 368(b). Thus, the dispute centers on the language in clause B requiring that one corporation acquire "in exchange solely for all or a part of its voting stock . . . stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation . . . ."
Taxpayers argue that the acquiring corporation must obtain "control" of the target corporation "solely for . . . voting stock," and that consideration other than voting stock is permissible under clause B if this precondition is met. The Commissioner disagrees, arguing that the acquiring corporation must obtain "control" in a transaction in which it exchanges voting stock and no other consideration. We conclude that no clear resolution of these competing arguments is apparent on the face of the statute. We must therefore analyze the widest range of available materials to derive an answer. This perforce makes our task exhaustive and requires an opinion that is more lengthy than we would prefer. But this task is necessary here because, as a reviewing court, we must examine and evaluate prior judicial constructions, the legislative history, the policies represented by each term in the statute, and the relationship of clause B to the overall statutory schema.
Our analysis of the judicial history of clause B must begin with the Supreme Court's decision in Helvering v. Southwest Consolidated Corp., 315 U.S. 194, 62 S. Ct. 546, 86 L. Ed. 789 (1942). That case arose under § 112(g)(1) of the Revenue Act of ...