Eastern Color Printing Co. v. Comm'r of Internal Revenue

• Decision Date: 21 October 1974
• Docket Number: Docket No. 6711-72.
• Citation: 63 T.C. 27
• Parties: THE EASTERN COLOR PRINTING COMPANY, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

63 T.C. 27

THE EASTERN COLOR PRINTING COMPANY, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 6711-72.

United States Tax Court

Filed October 21, 1974.

George G. Vest and Dorrance Sexton, Jr., for the petitioner.

Barry D. Gordon, for the respondent.

Held, in the transaction whereby petitioner acquired the assets and business of its subsidiary, meeting both the provisions of sec. 332, I.R.C. 1954, with respect to liquidation of a subsidiary and sec. 368(a)(1)(F) with respect to a reorganization which amounts only to a change in identity or form; petitioner is not prohibited by sec. 381(b)(3) from carrying back net operating losses or unused investment credit for years after the transaction to years of its former subsidiary prior to the transaction.

OPINION

SCOTT, Judge:

Respondent determined deficiencies in petitioner's income tax for the calendar years 1964 and 1965 in the amounts of $10,386.31 and $74,076.11, respectively.

The issue for decision is whether petitioner is entitled to carry back net operating losses and investment credits which arose after the merger into petitioner of its wholly owned subsidiary to eliminate income taxes of that subsidiary for years prior to the merger.

All of the facts have been stipulated and are found accordingly. Therefore, we will set forth in this opinion only those facts necessary to an understanding of the issue.

Petitioner is a Connecticut corporation which at the time of the filing of the petition in this case had its principal office in Waterbury, Conn.

Prior to October 1, 1966, petitioner had a wholly owned subsidiary, the Eastern Color Printing Co., hereinafter Old Eastern. During the years 1964 and 1965 Old Eastern used an accrual method of accounting and reported its income on the basis of a calendar year. It filed its Federal income tax returns for the years 1964 and 1965 with the district director of internal revenue at Hartford, Conn.

Petitioner was incorporated in 1953 as Mattatuck Associates, Inc., and under its certificate of incorporation, its activities were limited to being a holding company. After several transactions not here relevant, by 1955 petitioner's only asset was 80 percent of the stock of Old Eastern. From 1955 to 1960 petitioner owned 80 percent of the stock of Old Eastern and 20 percent was owned by third parties. In December 1960 Old Eastern redeemed the 20 percent of the shares not owned by petitioner, and thereafter was a wholly owned subsidiary of petitioner. From the time of its incorporation to October 1, 1966, petitioner was a holding company and its only assets were cash, its corporate name, and stock of Old Eastern or of the predecessor of Old Eastern. Petitioner's sole source of income prior to October 1, 1966, consisted of two dividends of $50,400 each paid to it by its subsidiary; Old Eastern, in 1964 and 1965. Old Eastern was engaged in the printing business, specializing in color printing for the periodical market.

On October 1, 1966, Old Eastern was merged into its parent, petitioner, pursuant to the laws of the State of Connecticut. After the merger petitioner continued the business conducted by Old Eastern prior to the merger. There was no change in the assets, location, or in the personnel or managements of Old Eastern. With minor exceptions the directors and officers of Old Eastern and petitioner prior to the merger were the same individuals and after the merger these same individuals, with the exception of one director of Old Eastern; were the officers and directors of petitioner.

In early 1966 petitioner's president requested a ruling from the Internal Revenue Service that the proposed merger of Old Eastern into petitioner would constitute a liquidation under the provisions of section 332, I.R.C. 1954, ¹ and would be governed by the relevant provisions of that section for the purposes of determining gain or loss, the basis of assets, and the treatment of earnings and profits. On July 20, 1966, petitioner received a letter from the Acting Chief, Reorganization Branch of the Internal Revenue Service, containing a ruling that provided the requirements of section 332(b) were met, (1) no gain or loss would be recognized to petitioner on its receipt of property distributed in complete liquidation of Old Eastern; (2) that under section 336, no gain or loss would be recognized to Old Eastern on the distribution of its property in complete liquidation; (3) that the basis of the property of Old Eastern received by petitioner would be the same as the basis of such property in the hands of Old Eastern; and (4) that the earnings and profits of Old Eastern as of the effective date of the liquidation would retain their character as earnings and profits in the hands of petitioner. This letter contained the further statement:

No opinion is expressed as to the tax treatment of the transaction under the provisions of any of the other sections of the Code and Regulations which may also be applicable thereto or to the tax treatment of any conditions existing at the time of, or effects resulting from, the transaction which are not specifically covered by the above ruling.

On July 25, 1966, Old Eastern held a meeting of its board of directors at which the letter from the Acting Chief of the Reorganization Branch of the Internal Revenue Service was presented. At the meeting the directors of Old Eastern voted that their counsel be instructed to proceed with the proposed merger.

On September 26, 1966, the proposed merger was approved by the shareholders of Old Eastern and on that same date was also approved by its board of directors. On September 28, 1966, the stockholders and board of directors of petitioner approved the merger of Old Eastern into petitioner, and on that date the certificate of merger between Old Eastern and petitioner was executed. On October 1, 1966, the certificate of merger was filed with the secretary of state of Connecticut. Pursuant to this certificate Old Eastern ceased to exist and its property became that of petitioner. All shares of Old Eastern which were owned by petitioner were canceled.

Petitioner filed a consolidated income tax return reporting a consolidated net loss of $39,547.19 for the calendar year 1966 with its subsidiary, Old Eastern. This return contained a statement by petitioner's president to the effect that the 1966 merger of Old Eastern into petitioner was a liquidation of a subsidiary under section 332. On this return no gain or loss was recognized by petitioner on receipt of Old Eastern's assets, and petitioner used as the basis of the assets the basis they had had in the hands of Old Eastern.

In 1967 and 1968 petitioner sustained net losses in the amounts of $83,379.99 and $400,150.89, respectively.

On July 10, 1969, petitioner filed an amended return for the taxable year 1966 and attached a statement thereto that the 1966 merger of Old Eastern into petitioner constituted a reorganization under section 368(a)(1)(F).

Based on this amended return, petitioner filed on July 9, 1969, a claim for a tentative carryback of its net operating losses from 1968 to the years 1965, 1966, and 1967. Prior thereto petitioner had filed a claim for a tentative carryback of unused investment credit from 1966 to 1964, claiming a refund of 1964 taxes of Old Eastern of $10,386.31, which tentative carryback claim had been allowed. The tentative carryback claim filed on July 9, 1969, of net operating loss to 1965 was likewise allowed in the amount of $74,076.11. Also on July 9, 1969, petitioner filed a claim on Form 843 seeking refund of $50,126.29 of taxes paid by Old Eastern for its calendar year 1964.

Respondent in his notice of deficiency determined the deficiencies here in issue with the explanation that the investment credit of $10,386.31 carried back from the taxable year 1966 to the taxable year 1964, and previously tentatively allowed, resulted in the deficiency because the credit was not allowable since there was a liquidation under section 332. For this same reason respondent determined a deficiency in the amount of the refund made on the basis of the tentative carryback claim of net operating loss from the taxable year 1968 to the taxable year 1965. Also, in the notice of deficiency respondent stated that if a petition were filed with the Tax Court, the issue set forth in the claim for refund filed by petitioner should be raised before this Court and the issue of the validity of this claim has been raised in this case by petitioner.

Petitioner's position is that the merger of Old Eastern into it on October 1, 1966, constituted a reorganization under section 368(a)(1)(F), and, therefore, in accordance with the provisions of section 381(b), it is entitled to the carrybacks of unused investment credit and net operating losses even though the merger might also constitute a liquidation within the provisions of section 332(a).

Respondent does not question the amount of unused investment credit and net operating losses claimed by petitioner. He also concedes (see fn. 4, p. 32 infra) that the transaction here involved falls within the description as set forth in section 368(a)(1)(F). He argues that petitioner is not entitled to the claimed carrybacks in that merger of Old Eastern into a petitioner constituted a liquidation under section 332(a) and that where such a liquidation has occurred a taxpayer is not entitled to exclusion from the provision of section 381(b) prohibiting the carryback of a net operating loss even though the acquisition may also meet the description of a reorganization under section 368(a)(1)(F).

Respondent's first argument is that if a transaction is such that it amounts to a liquidation within the meaning of section 332, only the provisions of that section may govern the application of section 381(b)(3)² to the transaction. He concludes that for this reason the provisions of section 381(b)(3) that in the case of acquisition other than one...