Pcoady v. Comm'r of Internal Revenue, Docket No. 70734.

• Citation: 33 T.C. 771
• Decision Date: 29 January 1960
• Docket Number: Docket No. 70734.
• Parties: EDMUND P.COADY AND VIRGINIA COADY, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: United States Tax Court

33 T.C. 771

EDMUND P.COADY AND VIRGINIA COADY, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 70734.

Tax Court of the United States.

Filed January 29, 1960.

Carl H. Tangeman, Esq., for the petitioners.

William O. Allen, Esq., for the respondent.

For more than 5 years prior to November 15, 1954, the Christopher Company was engaged in the active conduct of a construction business. Its stock was held 50 per cent by M. Christopher, and 50 per cent by petitioner. Differences arose between the two stockholders, and they agreed to divide the business. Accordingly, on November 15, 1954, the Christopher Company organized the Coady Company to which it transferred one-half its business assets in exchange for all of Coady Company's stock. The Christopher Company then distributed all the Coady Company stock to petitioner in exchange for all of his Christopher Company stock. Since the distribution, both companies have been actively engaged in the construction business. Held, the distribution to petitioner of the Coady Company stock qualified for tax-free treatment under the provisions of section 355 of the 1954 Code, and that portion of the Commissioner's regulations which denies such treatment to the division of a single business is invalid.

OPINION.

TIETJENS, Judge:

This proceeding involves a deficiency in income tax for the taxable year 1954 in the amount of $16,875, and an addition thereto under section 294(d)(2) of the 1939 Code in the amount of $1,012.50.

The issue for decision is whether the transfer by the Christopher Construction Company of a portion of its assets to E. P. Coady and Co. in exchange for all of the Coady Company's stock, and the subsequent distribution by the Christopher Company of such Coady stock to petitioner in exchange for his Christopher stock, constituted a distribution of stock qualifying for tax-free treatment on the shareholder level under the provisions of section 355 of the 1954 Internal Revenue Code.

All of the facts were stipulated, are so found, and are incorporated herein by this reference.

Edmund P. Coady (hereinafter referred to as the petitioner) and Virginia Coady, husband and wife and residents of Columbus, Ohio, filed their joint Federal income tax return for the taxable year 1954 with the district director of internal Revenue at Columbus, Ohio.

Christopher Construction Co., an Ohio corporation, is now engaged, and for more than 5 years prior to November 15, 1954, was engaged, in the active conduct of a construction business primarily in and around Columbus, Ohio. In an average year the Christopher Company undertook approximately 6 construction contracts, no one of which lasted for more than 2 years. Its gross receipts varied between $1,500,000 and $2,000,000 per year.

At its central office, located at 16 East Broad Street in Columbus, the Christopher Company kept its books of account, paid its employees, prepared bids for its jobs, and, excepting minor amounts of tools and supplies, made its purchases. In addition, it maintained temporary field offices at each jobsite. It also maintained a central repair and storage depot for its equipment. Equipment in use on particular jobs was kept at the jobsite until work was terminated. Then, it would either be returned to the central depot or moved to another jobsite.

At all times material hereto, the stock of the Christopher Company was owned by M. Christopher and the petitioner. For a number of years, petitioner owned 35 per cent of that stock and Christopher owned 65 per cent. However, on April 19, 1954, petitioner purchased 15 per cent of the total stock from Christopher. From that date until November 15, 1954, each owned 50 per cent of the company's stock.

Sometime prior to November 15, 1954, differences arose between the petitioner and Christopher. As a result, they entered into an agreement for the division of the Christopher Company into two separate enterprises. Pursuant to that agreement, the Christopher Company, on November 15, 1954, organized E. P. Coady and Co., to which it transferred the following assets, approximating one-half the Christopher Company's total assets:

A contract for the construction of a sewage disposal plant at Columbus, Ohio, dated June 1, 1954.

A part of its equipment.

A part of its cash, and certain other items.

In consideration for the receipt of these assets, E. P. Coady and Co. transferred all of its stock to the Christopher Company. The Christopher Company retained the following assets, which were of the same type as those transferred to E. P. Coady and Co.:

A contract for a sewage treatment plant in Charleston, West Virginia.

A part of its equipment.

A part of its cash.

Immediately thereafter, the Christopher Company distributed to the petitioner all of the stock of E. P. Coady and Co. held by it in exchange for all of the stock of the Christopher Company held by petitioner. The fair market value of the stock of E. P. Coady and Co. received by petitioner was $140,000. His basis in the Christopher Company stock surrendered was $72,500.

Since the distribution, both E. P. Coady and Co. and the Christopher Company have been actively engaged in the construction business.

On their 1954 Federal income tax return, petitioner and his wife reported no gain or loss on the exchange of the Christopher Company stock for the stock of E. P. Coady and Co.

Respondent determined that petitioner realized a capital gain on that exchange in the amount of $67,500, 50 per cent of which was taxable in 1954.

Petitioner contends that the distribution to him of the E. P. Coady and Co. stock qualified for tax-free treatment under the provisions of section 355 of the 1954 Code,¹ arguing that it was received pursuant to a distribution of a controlled corporation's stock within the meaning of that section.

Respondent on the other hand maintains petitioner's receipt of the Coady stock did not fall within those distributions favored by section 355, inasmuch as the 5-year active business requirements of 355(b) were not met. More particularly he argues that section 355 does not apply to the separation of a ‘single business'; and, inasmuch as the Christopher Company was engaged in only one trade or business (construction contracting), the gain realized by petitioner upon receipt of the Coady stock was taxable. As authority for his position respondent points to that portion of his regulations which expressly provides that section 355 does not apply to the division of a single business.²

Conceding that the Christopher Company was engaged in a ‘single business' immediately prior to the instant transaction, petitioner contends that the regulations, insofar as they limit the applicability of section 355 to divisions of only those corporations which have conducted two or more separate and distinct businesses for a 5-year period, are without support in the law, are without justification, are unreasonable and arbitrary, and therefore are invalid.

Thus, the issue is narrowed to the question of whether the challenged portion of the regulations constitutes a valid construction of the statute, or whether it is unreasonable and plainly inconsistent therewith. Though this appears to be a case of first impression, the question has not gone without comment. ³

Section 355 of the 1954 Code represents the latest of a series of legislative enactments designed to deal with the tax effect upon shareholders of various corporate separations. Where the 1939 Code contained three sections, 112(b) (3), 112(b)(11), and 112(g)(1)(D), which controlled the tax impact of these exchanges, present law groups the statutory requirements into two sections, 355 and 368(c). A careful reading of section 355, as well as the Finance Committee report⁴ which accompanied its enactment, reveals no language, express or implied, denying tax-free treatment at the shareholder level to a transaction, otherwise qualifying under section 355, on the grounds that it represents the division or separation of a ‘single’ trade or business.

In general, section 355(a) prescribes the form in which a qualifying transaction must be cast, providing that a divisive distribution will not give rise to taxable gain or loss if: (1) The distributing corporation distributes stock or securities of a corporation of which it has, immediately prior to the distribution, 80 per cent control as defined in section 368(c); (2) the distribution is not principally a device for distributing earnings and profits of either the distributing or controlled corporations; (3) the 5-year active business requirements of 355(b) are satisfied; and (4) the distributing corporation distributes either all its stock and securities in the controlled corporation, or so much thereof as constitutes control, as defined in 368(c), and retention of the balance is shown not to be in pursuance of a plan having as one of its principal purposes tax avoidance. The distribution itself must be either to a shareholder with respect to its stock, or a security holder with respect to its securities. With respect to a distribution of stock, the distribution need not be on a pro rata basis; the shareholder need not surrender stock in the distributing corporation; and the distribution need not have been made in pursuance of a plan of reorganization. However, subsection (a) contains no language which would require that the distributing corporation be engaged in more than one trade or business prior to the distribution.

The active business requirements of 355(b)(1) prohibit the tax-free separation of a corporation into active and inactive entities. Section 355(b)(1)(A) extends the provisions of 355(a) only to those divisive distributions where the distributing corporation and the controlled corporation are engaged immediately after the distribution in the active conduct of a trade or business. In the case of those distributions which involve liquidation of the transferor, 355(b) (1)(B) requires that...