76 T.C. 972 (1981)| 8083-77, McDonald'S of Zion v. C.I.R.

Docket Nº:8083-77--8109-77.
Citation:76 T.C. 972
Opinion Judge:HALL, Judge
Attorney:Sheldon I. Fink, Frederic S. Lane, and Steven W. Swibel, for the petitioners. Seymour I. Sherman, for the respondent.
Case Date:June 11, 1981
Court:United States Tax Court

Page 972

76 T.C. 972 (1981)

MCDONALD'S of ZION, 432, ILL., INC., ET AL., [1]



Nos. 8083-77--8109-77.

United States Tax Court

June 11, 1981

McDonald's Corp. (McDonald's) wanted to acquire several franchised restaurants owned primarily by three individuals, Garb, Stern, and Imerman (the Garb-Stern group). McDonald's refused to offer any consideration other than its common stock because of financial accounting reasons. Although the Garb-Stern group wanted a cash transaction, they eventually agreed to accept 361,235 shares of unregistered common stock. The merger took place as of Apr. 1, 1973, whereupon McDonald's dropped down the acquired restaurants into wholly owned, operating subsidiaries (the petitioners herein). As part of the merger agreement, the Garb-Stern group received " piggyback" registration rights plus a demand registration right. From the beginning, the Garb-Stern group intended to sell virtually all of the McDonald's stock they received pursuant to the merger agreement. No member of the group, however, promised or obligated himself to sell any of the shares received. McDonald's was totally indifferent as to whether the Garb-Stern group retained or sold their stock. The Garb-Stern group sold all but 100 shares of their McDonald's stock on Oct. 3, 1973, by exercising their " piggyback" registration rights. This date was the group's earliest opportunity to sell the stock received pursuant to the Apr. 1 merger. Held : The acquisition by McDonald's of the franchised restaurants constitutes a valid " A" reorganization. The Garb-Stern group's intent to sell the McDonald's stock acquired pursuant to the statutory merger, coupled with their subsequent sale of such stock at the earliest opportunity, does not violate the continuity-of-interest principle.

Page 973

Sheldon I. Fink, Frederic S. Lane, and Steven W. Swibel, for the petitioners.

Seymour I. Sherman, for the respondent.

HALL, Judge :

Respondent determined deficiencies in petitioners' 1973 Federal income tax as follows:

Amount of
Petitioner Docket No. deficiency
McDonald's of Zion
432, Ill., Inc 8083-77 $14,940
McDonald's of Castro Valley,
433, Calif., Inc 8084-77 22,766
McDonald's of Concord-Clayton,
434, Calif., Inc 8085-77 9,641
McDonald's of San Leandro,
435, Calif., Inc 8086-77 26,372
McDonald's of Oakland, 12th St.,
436, Calif., Inc 8087-77 15,444
McDonald's of Alameda,
437, Calif., Inc 8088-77 14,677
McDonald's of Pomona,
438, Calif., Inc 8089-77 6,633
McDonald's of Grand Rapids-28th St.,
439, Mich., Inc 8090-77 34,106
McDonald's of Grand Rapids-Plainfield,
440, Mich., Inc 8091-77 28,487
McDonald's of Grand Rapids-Division,
441, Mich., Inc 8092-77 12,285
McDonald's of Walker,
442, Mich., Inc 8093-77 16,492
McDonald's of Bethany,
443, Okla., Inc 8094-77 16,167
McDonald's of Midwest City,
444, Okla., Inc 8095-77 16,752
McDonald's of Norman,
445, Okla., Inc 8096-77 21,659
McDonald's of Oklahoma City-29th St.,
446, Okla., Inc 8097-77 31,457
McDonald's of Oklahoma City-39th St.,
447, Okla., Inc 8098-77 29,697
McDonald's of Oklahoma City-May,
448, Okla., Inc 8099-77 29,237
McDonald's of Oklahoma City-Penn.,
449, Okla., Inc 8100-77 33,796
McDonald's of Oklahoma City-23d,
450, Okla., Inc 8101-77 23,760
McDonald's of Tulsa,
451, Okla., Inc 8102-77 25,174
McDonald's of Tulsa-Yale,
452, Okla., Inc 8103-77 16,457
McDonald's of Tulsa-11th St.,
453, Okla., Inc 8104-77 25,892
McDonald's of Del City,
454, Okla., Inc 8105-77 13,731
McDonald's of Moore,
455, Okla., Inc 8107-77 15,203
McDonald's of Enid
456, Okla., Inc 8106-77 14,188
McDonald's of Kenosha,
457, Wis., Inc 8108-77 23,257
McDonald's of Kenosha-52d St.,
458, Wis., Inc 8109-77 28,133
Page 974 Each petitioner obtained its assets from McDonald's Corp. following the latter's acquisition of those assets by merger. Due to concessions, the sole issue for decision is whether the transaction by which McDonald's Corp. obtained these assets qualified as a tax-free reorganization. Page 975 FINDINGS OF FACT At all pertinent times, each petitioner was a wholly owned subsidiary of McDonald's Corp. (McDonald's), a Delaware corporation. Each petitioner had its principal place of business in Oak Brook, Ill., when it filed its petition in these cases. All petitioners maintain their books and records on the accrual method and file their tax returns on a calendar year basis. McDonald's and its subsidiaries operate, license, and service a system of self-service restaurants offering a substantially uniform menu. The McDonald's restaurant operations include proprietary outlets owned and operated by independent licensees or franchisees. Between January 1, 1968, and June 30, 1973, McDonald's acquired the stock or assets of corporations or other entities which owned an aggregate of 303 franchised restaurants. Melvin Garb, Harold Stern, and Lewis Imerman (sometimes hereinafter referred to as the Garb-Stern group) first became involved with the McDonald's organization in the late 1950's when they obtained franchise rights to operate a restaurant in Saginaw, Mich. They subsequently expanded their McDonald's restaurant operations to include stores in other areas of Michigan, and in certain areas of Oklahoma, Wisconsin, Nevada, and California. Certain of the Garb-Stern restaurants were placed in wholly or partially owned subsidiaries of McDonald's Distributing Corp. (Distributing), a Michigan corporation, owned equally by Garb, Stern, and Imerman. Each subsidiary contained one restaurant. The remainder of the Garb-Stern interests were held by affiliated companies. [2] (Distributing, its subsidiaries, and the affiliated companies will sometimes be referred to collectively as the Garb-Stern Cos.) Garb, Stern, and Imerman always owned equal shares in their McDonald's endeavors. They each owned one-third of the outstanding stock in Distributing as well as the same number of Page 976 shares in each of the affiliated corporations in which they were shareholders. Any decision relating to their McDonald's interests generally required the unanimous approval of the group. Garb generally acted as the group's spokesman in its dealings with the McDonald's organization.[3] In 1968, McDonald's, Distributing, Garb, Stern, and Imerman entered into an agreement whereby McDonald's acquired all the outstanding common stock of 14 subsidiaries of Distributing in exchange solely for $2.3 million par value, convertible, 6-percent preferred McDonald's stock. The preferred shares received by Distributing were not registered under the Securities Act of 1933 nor were they transferable for 2 years pursuant to the terms of the 1968 agreement. For many years, the Garb-Stern group and the McDonald's organization maintained a congenial and successful relationship. The Garb-Stern group led by Garb, an outspoken and gregarious individual, became one of the largest and best-known franchisees within the McDonald's organization. Sometime after the 1968 transaction, however, the relationship between McDonald's and the Garb-Stern group soured. In the fall of 1971, McDonald's and the Garb-Stern group met to discuss the possible acquisition by McDonald's of certain restaurants in Oklahoma. These negotiations proved to be unfruitful because accounting rules then in effect precluded McDonald's from treating the proposed acquisition as a " pooling of interests" [4] unless all the operations of the Garb-Stern group Page 977 were acquired. At that time, McDonald's was unwilling to acquire all of the Garb-Stern interests.[5] The parties resumed their negotiations in November 1972 with a meeting at La Costa, Calif. At that meeting, the parties explored the possibility of McDonald's acquiring all the Garb-Stern Cos.[6] Most of the discussion at La Costa related to the nature and amount of consideration McDonald's would pay for the Garb-Stern interests. Garb, the spokesman for the group, indicated a desire for all cash. McDonald's, however, would only consider an acquisition that could be accounted for as a pooling of interests.[7] Under then-prevailing accounting rules, the acquisition could qualify as a pooling of interests only if McDonald's issued its common stock in exchange for the Garb-Stern interests.[8] McDonald's representatives suggested that the conflicting interests of both sides could be satisfied through the Page 978 following procedure: McDonald's would acquire the Garb-Stern Cos. in exchange for McDonald's common stock, and McDonald's would permit the Garb-Stern group to include their shares for sale in a June registration then planned by McDonald's.[9] The 2-day meeting at La Costa ended at an impasse primarily because the parties could not agree on the value of the Garb-Stern interests. By the conclusion of the meeting, however, both parties recognized that any eventual acquisition would be in exchange for McDonald's common stock. In early March 1973, Stuart Greenberger, the attorney for the Garb-Stern group, met with McDonald's general counsel in order to convey an offer on behalf of the Garb-Stern group. On March 12, 1973, Greenberger wrote the following letter to McDonald's general counsel setting forth the basic terms of his clients' offer: As you requested, I am writing this letter in order to put in writing the basic terms of the " offer" which, on behalf of my clients, I transmitted to you at our breakfast meeting last Wednesday...

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