Commissioner of Internal Revenue v. Phipps

• Decision Date: 14 March 1949
• Docket Number: No. 83,83
• Citation: 69 S.Ct. 616,336 U.S. 410,93 L.Ed. 771
• Parties: COMMISSIONER OF INTERNAL REVENUE v. PHIPPS
• Court: U.S. Supreme Court

336 U.S. 410

69 S.Ct. 616

93 L.Ed. 771

COMMISSIONER OF INTERNAL REVENUE

v PHIPPS.

No. 83.

Argued Dec. 9, 1948.

Decided March 14, 1949.

Mr. Stanley M. Silverberg, of Washington, D.C., for petitioner.

Messrs. Montgomery Dorsey and W. Clayton Carpenter, both of Denver, Colo., for respondent.

Mr. Justice MURPHY delivered the opinion of the Court.

This case involves a tax-free liquidation by a parent corporation of some of its subsidiaries. At the time of the liquidation the parent had earnings and profits available for distribution, and the subsidiaries had an aggregate net deficit. The issue now before us is whether the rule of Commissioner v. Sansome, 2 Cir., 60 F.2d 931, requires the subtraction of the subsidiaries' deficit from the parent's earnings and profits, in determining whether a subsequent distribution by the parent constituted dividends or a return of capital to its stockholders.

The Sansome case, supra, arose from a tax-free reorganization in which the transferor corporation had a surplus in earnings and profits available for distribution. It was there held that those earnings and profits, for purposes of a subsequent distribution by the transferee corporation to its stockholders, retain their status as earnings or profits and are taxable to the recipients as dividends. The rule has been held to include liquidations of a subsidiary by its parent. Robinette v. Commissioner, 9 Cir., 148 F.2d 513; U.S.Treas.Reg. 101, Art 115—11, promulgated under the Revenue Act of 1938, 26 U.S.C.A.Int.Rev.Acts, page 1001 et seq., and made retroactive.

The facts were stipulated, and so found by the Tax Court. So far as relevant, they are as follows: In December, 1936, Nevada-California Electric Corporation liquidated five of its wholly owned subsidiaries by distributing to itself all of their assets, subject to their liabilities, and by redeeming and canceling all of their outstanding stock. No gain or loss on the liquidation was recognized for income tax purposes under § 112(b)(6) of the Revenue Act of 1936, 26 U.S.C.A.Int.Rev.Acts, pages 855, 856.¹ On the date of liquidation, one of the subsidiaries had earnings and profits accumulated after February 28, 1913, in the amount of $90,362.77. The four others had deficits which aggregated $3,147,803.62. On December 31, 1936, the parent had earnings and profits accumulated after February 28, 1913, in the amount of $2,129,957.81, which amount does not reflect the earnings or deficits of the subsidiaries. In 1937, Nevada-California had earnings of $390,387.02. In the years 1918 to 1933 inclusive the parent and its subsidiaries filed consolidated income tax returns.²

Respondent was the owner of 2,640 shares o the preferred stock of Nevada-California. During 1937 that corporation made a prorata cash distribution to its preferred stockholders in the amount of $802,284, of which respondent received $18,480. The Commissioner determined that the distribution was a dividend under § 115 of the Revenue Act of 1936, 26 U.S.C.A.Int.Rev.Acts, page 868,³ and constituted ordinary income in its entirety.

Of the 1937 distribution, approximately 49% was chargeable to earnings and profits of the taxable year. Consequently, respondent conceded in the Tax Court that that percentage of her share, or about $9,000, was taxable as a dividend under § 115(a)(2). The Tax Court held in her favor that the balance was not a taxable dividend out of earnings and profits, on the theory that all of Nevada-California's accumulated earnings and profits, plus the accumulated earnings and profits of the subsidiary that had a surplus, were erased by the aggregate deficits of the other four subsidiaries.⁴ 8 T.C. 190. The Court of Appeals, 10 Cir., affirmed by a divided court, 167 F.2d 117. We brought the case here on a writ of certiorari, 335 U.S. 807, 69 S.Ct. 33, because of its importance in the administration of the revenue laws, and because of an alleged conflict of the decision below with that of the Court of Appeals for the Ninth Circuit in Cranson v. United States, 146 F.2d 871.

Commissioner v. Sansome, 2 Cir., 60 F.2d 931, arose thus: A Corporation sold out all its assets to B Corporation, both organized under the laws of New Jersey. B Corporation assumed all liabilities and issued its stock to the stockholders of A Corporation, without change in the proportions of their holdings. The only change was that the charter of B Corporation gave it slightly broader powers. At the time of the reorganization, A Corporation had on its books a large surplus and undivided profits. The new corporation made no profit and the company soon dissolved. The liquidating distributions in 1923, the year when the dissolution was begun, did not exhaust the amount of accumulated profits of the predecessor corporation, and the Commissioner contended that those distributions were taxable to the stockholders as dividends and not, as claimed by them, as a return of capital. The Court of Appeals for the Second Circuit agreed with the Commissioner, and held that since the reorganization was nontaxable under § 202(c)(2) of the Revenue Act of 1921, 42 Stat. 230, the accumulated earnings and profits of the transferor retained their character as such for tax purposes in the h nds of the transferee and were consequently taxable on distribution as ordinary income under § 201 of the same Act, 42 Stat. 228.⁵ The view of the court was thus expressed by Judge Learned Hand: 'Hence we hold that a corporate reorganization which results in no 'gain or loss' under section 202(c)(2) (42 Stat. 230) does not toll the company's life as continued venture under section 201, and that what were 'earnings or profits' of the original, or subsidiary, company remain, for purposes of distribution, 'earnings or profits' of the successor, or parent, in liquidation.' 60 F.2d 931, 933. The rule has been consistently followed judicially⁶ and has received explicit Congressional approval.⁷

The rationale of the Sansome decision as a 'continued venture' doctrine has been often repeated in the cases, and in some of them the fact that the successor corporation has differed from the predecessor merely in identity or form⁸ has lent it plausibility. Other cases, however, demonstrate that the 'continued venture' analysis does not accurately indicate the basis of the decisions. The rule that earnings and profits of a corporation do not lose their character as such by virtue of a tax-free reorganization or liquidation has been applied where more than one corporation has been absorbed or liquidated,⁹ where there has been a 'split-off' reorganization,¹⁰ and where the reorganization has resulted in substantial changes in the proprietary interests.¹¹

In Commissioner v. Munter, 331 U.S. 210, 67 S.Ct. 1175, 91 L.Ed. 1441, this Court reversed a decision of the Court of Appeals for the Third Circuit, 157 F.2d 132, which had held in favor of the taxpayer on the ground that the ownership of the successor corporation was so different from that of the two predecessors that there was not sufficient continuity of the corporate entity to apply the Sansome doctrine. The opinion of the Court stated our unanimous view of the basis of the rule: 'A basic principle of the income tax laws has long been that corporate earnings and profits should be taxed when they are distributed to the stockholders who own the distributing corporation. * * * Thus unless those earnings and profits accumulated by the predecessor corporations and undistributed in this reorganization are deemed to have been acquired by the successor corporation and taxable upon distribution by it, they would escape the taxation which Congress intended. * * * The congressional purpose to tax all stockholders who receive distributions of corporate earnings and profits cannot be frustrated by any reorganization which leaves earnings and profits undistributed in whole or in part.' 331 U.S. at pages 214, 215, 67 S.Ct. at page 1177, 91 L.Ed. 1441. See Murchison's Estate v. Commissioner, 5 Cir., 76 F.2d 641, 642; Putnam v. United States, 2 Cir., 149 F.2d 721, 726; Samuel L. Slover, 6 T.C. 884, 886. We concluded from the cases that the Sansome rule is grounded not on a theory of continuity of the corporate enterprise but on the necessity to prevent escape of earnings and profits from taxation.

The decision of the Court of Appeals for the Second Circuit in Harter v. Helvering, 79 F.2d 12, is not inconsistent with this view. In that case the situation was as follows: A Corporation and B Corporation, each of which had accumulated earnings and profits merged to form C Corporation. By the operation of the Sansome rule, the earnings and profits retained their character as such in the hands of C. Some time later, D Corporation acquired all the stock of C, and thereafter liquidated it in a transaction in which no gain or loss was recognized. At the time of the liquidation of C Corporation, D Corporation, the parent, had a deficit in earnings and profits. The court held, in determining the amount of earnings and profits available to D Corporation after the liquidation for distribution as dividends, that its deficit should be deducted from the accumulated earnings and profits acquired from its subsidiary. It is vigorously contended that the logic of the Harter case compels the allowance of a deduction of the deficits of the subsidiaries from the accumulated earnings and profits of the parent. We believe this view to be the product of inadequate analysis.¹² The difference between the Harter situation and the problem before us may perhaps be clarified by comparing them taxwise if neither liquidation had occurred. Briefly stated, in the case of a distribution to a corporation with a deficit from either current or prior losses, the corporation receiving the distribution has no taxable income or earnings or profits available for current distribution until current income excees current losses, and no accumulated earnings or profits until its...