Roebling v. Commissioner of Internal Revenue

• Decision Date: 01 July 1944
• Docket Number: No. 8519.,8519.
• Citation: 143 F.2d 810
• Parties: ROEBLING v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

143 F.2d 810 (1944)

ROEBLING v. COMMISSIONER OF INTERNAL REVENUE.

No. 8519.

Circuit Court of Appeals, Third Circuit.

Argued January 20, 1944.

Decided July 1, 1944.

Floyd F. Toomey, of Washington, D. C. (Ellsworth C. Alvord of Washington, D. C., and Ferdinand Tannenbaum, of New York City, New York, on the brief), for petitioner.

Ray A. Brown, of Washington, D. C. (Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key, and J. Louis Monarch, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before JONES and McLAUGHLIN, Circuit Judges, and KALODNER, District Judge.

KALODNER, District Judge.

This appeal presents three questions: (1) Whether the transaction hereafter stated between a lessor corporation and a lessee corporation constitued a "statutory merger", within the meaning of Sec. 112(g) (1) (A) of the Revenue Act of 1938, 26 U.S.C.A. Int.Rev.Code, § 112(g) (1) (A);¹ (2) whether the doctrine of "continuity of interest" as enunciated in LeTulle v. Scofield, 308 U.S. 415, 60 S.Ct. 313, 84 L.Ed. 355, applies to a "statutory merger", and (3) whether under the facts a "continuity of interest" actually existed.

Taxability on gain resulting to the petitioner on the exchange of stock in the lessor corporation for bonds of the lessee corporation under the provisions of Sec. 112(b) (3) of the Revenue Act of 1938² depends on the disposition of the issues above stated.

The facts are all stipulated. Summarized they are as follows:

Petitioner, an individual residing in Trenton, New Jersey, filed a Federal income tax return for the calendar year 1938 with the Collector of Internal Revenue for the First District of New Jersey.

On December 5, 1935, petitioner acquired by gift 166 shares of the stock of South Jersey Gas, Electric and Traction Co. (hereinafter referred to as South Jersey). This stock had been acquired by petitioner's donor on March 12, 1914, at a cost of $16,600.

South Jersey was a corporation organized on August 31, 1900, under the laws of the State of New Jersey, for the purpose of furnishing electricity and gas for public and private use in that state.

In June, 1903, South Jersey had leased all its franchises, plants and operating equipment to Public Service Corporation of New Jersey for 900 years. The lessee was to pay rent which beginning December 1, 1908, amounted to $480,000 per annum. In addition the lessee agreed to pay the interest charges on the lessor's bonded indebtedness, all taxes, insurance and such sums as were necessary to maintain, repair, improve and extend the leased properties. All replacements and additions became the property of South Jersey subject to the terms of the lease.

The lease further provided that upon default of the terms of the lease for a period of 30 days, after notice, South Jersey could terminate the lease, reenter and reacquire the property and additions and extensions thereto.

Under the terms of the lease South Jersey could enter upon the leased property for the purpose of inspecting it and determining its condition and the character of the management and whether the covenants of the lease were being complied with.

In July, 1924, this lease was assigned by Public Service Corporation of New Jersey to Public Service Electric and Gas Company which assumed the obligations thereof.

From December 1, 1908, to June 1, 1937, the net rentals received by South Jersey, the lessor company, were distributed to its stockholders at the rate of 8% per annum on the par value of its stock. South Jersey had outstanding 60,000 shares of capital stock of $100 par value, of which Public Service Electric and Gas Company, the assignee of the lease, held 1,705 shares, and Public Service Corporation of New Jersey, the original lessee, held 15,773 shares. The remaining 42,521 shares were held by other interests. Public Service Corporation of New Jersey held substantially all the voting stock of Public Service Electric and Gas Company.

Public Service Electric and Gas Company as a part of its unified electrical system held and operated under long-term leases the properties of many other utility companies. For more than ten years Public Service and its parent, Public Service Corporation of New Jersey, had engaged in a systematic effort to acquire the fee to these properties, and by 1927 had acquired more than two-thirds of the stock of certain of these lessor companies. A projected merger of the lessee companies into Public Service Electric Gas through the exchange of stock in the lessor companies for 6% cumulative preferred stock of Electric and Gas callable in three years was enjoined by the Chancery Court of New Jersey as unfair to the minority stockholders of those companies. Outwater v. Public Service Corporation, 103 N.J.Eq. 461, 143 A. 729.

On May 10, 1937, the directors of South Jersey and of Public Service Electric and Gas Company adopted a "Plan of Reorganization" under which it was proposed that the former company be merged into the latter in accordance with the statutes of New Jersey. This plan provided that the stockholders of South Jersey (other than Public Service Electric and Gas Company) should exchange, dollar for dollar, their stock in South Jersey for 8% one hundred years first mortgage bonds of Public Service Electric and Gas Company. These bonds were to be issued under a prior mortgage of Public Service Electric and Gas Company dated August 1, 1924, and under a supplemental indenture later to be executed. It was expressly provided in the "Agreement of Merger" executed on the same day: "The capital stock of the Public Service Electric and Gas Company * * * will not be changed by reason of this agreement." Also, the stock of South Jersey held by Public Service Electric and Gas Company was not to participate in the exchange but was to be delivered up and cancelled.

The "Agreement of Merger" was accepted by the stockholders of South Jersey and of Public Service Electric and Gas Company, and approved by the Board of Public Utilities Commissioners of the State of New Jersey and by the Federal Power Commission. The "Agreement of Merger" with the certificates of the secretaries of the constituent companies as to the confirmatory votes of the stockholders, and the certificates of approval of the Public Utility Commissioners of New Jersey and of the Federal Power Commission was filed with the Secretary of State of New Jersey on November 17, 1938.

The "Agreement of Merger" was consummated pursuant to its provisions. In accordance therewith the taxpayer received in exchange for his 166 shares of stock in South Jersey, $16,600, principal amount of 8% bonds which on November 25, 1938, had a fair market value of $34,777.

The Commissioner determined that the difference between the basis of the taxpayer's stock in South Jersey and the fair market value of the bonds received in exchange therefor must be recognized as taxable income in 1938 and he asserted a deficiency which the Tax Court sustained, so far as it was based upon this item.

The issues presented here arise by reason of taxpayer's contention (1) that the merger of South Jersey into Public Service Electric and Gas Co. was a "true statutory merger" under the laws of the state of New Jersey and therefore the exchange of stock for bonds was not a taxable event under Sec. 112 of the Revenue Act of 1938; (2) that since there was a "true statutory merger" the "continuity of interest" doctrine in the LeTulle v. Scofield case is inapplicable and (3) that in any event a "continuity of interest" actually existed in the instant case.

As to the taxpayer's first two contentions, which may be considered together: The admitted fact that the merger of the two corporations was a "true statutory merger" under the New Jersey law is not dispositive of the question as to whether there was a "statutory merger" here within the meaning of Sec. 112(g) (1) (A). It is well-settled that a State law cannot alter the essential characteristics required to enable a taxpayer to obtain exemption under the provisions of a Federal Revenue Act.³

We so held in Commissioner of Internal Revenue v. Gilmore's Estate, 3 Cir., 130 F.2d 791. Indeed that case is completely dispositive of the taxpayer's first two contentions. In Gilmore's Estate we found that though there was, in that case, a "true statutory merger" under the identical laws of New Jersey involved here, (1) such "true statutory merger" is insufficient without more to qualify as a "reorganization" under the Revenue Act, and (2) that a "continuity of interest" as enunciated in numerous decisions of the Supreme Court of the United States and the pertinent Treasury Regulation 101⁴ must still be present to establish a true reorganization. In Gilmore's Estate we said, on page 794:

"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. Our concern in this case is the `something more' since we have concluded that there was a literal compliance. * * *

"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. * * *" (emphasis supplied)

Morgan Manufacturing Co. v. Commissioner, 4 Cir., 124 F.2d 602, is in agreement with our ruling in Gilmore's Estate. In Helvering v. Alabama Asphaltic Limestone Co., 1942, 315 U.S. 179, at page 182, 62 S.Ct. 540, at page 542, 86 L.Ed. 775, the Supreme Court of the United States succinctly stated the rule as follows:

"From the Pinell...