Solitron Devices, Inc. v. Comm'r of Internal Revenue

Decision Date10 January 1983
Docket NumberDocket No. 8313-78.
Citation80 T.C. 1
PartiesSOLITRON DEVICES, INC., PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Petitioner was engaged in the business of designing, manufacturing, and marketing electronic components. In 1968, it decided to enter the microwave industry. After several unsuccessful attempts to acquire large microwave manufacturing companies, petitioner began to acquire a number of smaller companies which collectively could offer the broad product mix of the larger competitors. Pursuant to this strategy, petitioner purchased GRFF, a manufacturer primarily engaged in the custom connector business. After abbreviated negotiations, petitioner purchased all of the stock of GRFF on Aug. 29, 1968, for $3.9 million cash, of which $600,000 was attributable to realty and $958,551 to tangible assets.

On Jan. 13, 1969, GRFF was liquidated and its assets transferred to a wholly owned subsidiary of petitioner. After the purchase of GRFF, petitioner began to alter the operations of that corporation. Accordingly, New GRFF, the wholly owned subsidiary into which GRFF's assets were transferred, began to undergo a change in product mix and a restructuring of product line, thereby transforming its products from specialty products to a standard line of products. This transformation took 11;2 to 2 years. Sometime in early 1971, New GRFF was liquidated by petitioner.

On its tax return for the year ended Feb. 28, 1971, petitioner claimed an abandonment loss deduction of $2,341,449 on the ground that it abandoned an intangible asset derived from GRFF's reputable image as a custom connector manufacturer. Held: GRFF possessed goodwill and going-concern value equal to the amount paid by petitioner to purchase that corporation in excess of the value attributable to GRFF's realty and tangible assets. Petitioner did not spontaneously create goodwill by such acquisition. Held, further, such intangible assets were transferred into petitioner's wholly owned subsidiary along with the underlying tangible assets of GRFF. Held, further: Petitioner has not proven that the assets of New GRFF were distributed to it in liquidation at any time prior to the end of its taxable year ended Feb. 28, 1971. Accordingly, petitioner is not entitled to the abandonment loss deduction for such year and we need not decide whether such abandonment actually took place during that period. John Y. Taggart and M. Jack Duksin, for the petitioner.

David M. Kirsch, for the respondent.

STERRETT , Judge:

By notice of deficiency dated April 20, 1978, respondent determined a deficiency in petitioner's Federal income tax for the taxable year ended February 28, 1970, in the amount of $981,762. The issues for decision are (1) whether petitioner purchased certain intangible assets previously held by General RF Fittings, Inc. (hereinafter GRFF), upon its acquisition of the stock of GRFF or whether petitioner created such intangible assets in itself by such acquisition; (2) whether, upon liquidation of GRFF, petitioner received such intangible assets to which it must allocate the attributable portion of its basis in the GRFF stock; (3) whether petitioner transferred all assets received upon the liquidation of GRFF, including the intangible assets, to a preexisting subsidiary, Integronics, Inc. (hereinafter New GRFF); (4) assuming that the intangible assets are found to have belonged to New GRFF, whether the assets of New GRFF were transferred to petitioner at any time prior to March 1, 1971; and (5) if it is found that petitioner owned the intangible assets during the fiscal year ended February 28, 1971, whether petitioner abandoned such assets during the fiscal year ended February 28, 1971.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference.

Petitioner Solitron Devices, Inc., was at all times material herein a New York corporation having its principal place of business in Tappan, N.Y. Petitioner's principal place of business at the time of filing the petition herein was Riviera Beach, Fla. The returns for the taxable years ended February 28, 1970, and February 28, 1971, were filed timely with the Internal Revenue Service Center, Andover, Mass. Petitioner did not file consolidated income tax returns with its subsidiaries at any time prior to its taxable year beginning March 1, 1970. Petitioner filed a consolidated income tax return for its taxable year ended February 28, 1971.

At all times material herein, petitioner was engaged in the business of designing, manufacturing, and marketing electronic components, including semiconductor devices. Petitioner was very successful in this business, having experienced a growth of sales from $8.5 million in 1966 to more than $18 million in 1968. It had the image of an innovative and dynamic electronics company in the forefront of the development and marketing of semiconductors.

Early in 1968, petitioner decided to enter the microwave field, an area in which it previously had not been engaged, and to attempt to gain an immediate reputation as a microwave company. This decision was kindled by petitioner's perception that there would be significant growth in the microwave communications business in the ensuing years.1

Petitioner believed that there would be rapid movement by other companies into the microwave field. Thus, it appeared necessary for it to gain an immediate presence or reputation as a microwave component manufacturing company in order to compete successfully. Petitioner understood that it would be unable to gain an immediate reputation or presence if it relied solely upon internal growth, for it would take anywhere from 18 months to 2 years to produce and market a newly conceived microwave connector2 and from 3 to 5 years to establish a reputation in the industry as a reliable source for the product. Therefore, it chose to enter the microwave business through the purchase of companies already engaged in that business.

Petitioner first made an unsuccessful stock tender offer for Ampherol Corp., a major electronics company which was a significant microwave component manufacturer. Petitioner realized an unexpected profit of more than $29 million as a result of this unsuccessful offer. Thus, petitioner had adequate funds to engage in a cash acquisition program. Petitioner also sought unsuccessfully to acquire Microwave Associates, one of the largest independent microwave companies, and a company with a record of $20 million in sales.

Petitioner then began to eye a number of smaller companies with the objective of entering the microwave industry by acquiring companies that collectively could offer a broad product line. This would allow petitioner to compete with such companies as Microwave Associates, a company which at that time offered the type of product mix that petitioner sought. Petitioner would have attempted to purchase any company in the microwave field that provided a product that fit within the spectrum that petitioner coveted. Conversely, petitioner would not have attempted to purchase two companies that made the identical product; the acquisition of only one would have satisfied petitioner's needs.

After deciding to acquire a number of smaller microwave companies, petitioner became interested in General RF Fittings, Inc., a company that manufactured microwave connectors.3 GRFF's business consisted of the manufacture of electronic connectors in limited quantities for microwave applications in missiles, satellites, avionics, and undersea use, where size, weight, and premium operating performance were required. It was considered a high-quality, job-order specialty house.

GRFF was highly regarded in the connector industry, having had substantial before-tax profits generated from sales exceeding $1 million for the previous 5 years. It had a good reputation with its customers and was known for producing quality products. It was known as a dependable supplier that delivered on time, and, because it was a pioneer in the development of the product it manufactured, occupied a somewhat unique position in the industry. Its image as a reputable microwave connector company made it attractive to petitioner.

GRFF was engaged primarily in the custom connector business. The type of connector in which it specialized represented a very small fraction of the connector market. GRFF developed its connector business in the TNC and stainless steel areas. A TNC connector is not a specific type of connector, but encompasses a broad range of types and sizes. It is a threaded, medium-sized, medium-power connector with only a limited market. GRFF had continued as a manufacturer of custom connectors and, in this respect, had deviated from the trend of the industry as a whole, which was to concentrate on the miniature and subminiature types of connectors and on the types of standardized connectors that would be covered by military specification.4

GRFF was a high-grade machine shop. It had no secret formulas or patented drawings of value. The equipment in GRFF's plant was ordinary machinery for working metal and plating, with little specialized equipment. GRFF filled specific customer orders in small quantities with connectors made to order. It did not produce connectors in volume or by using mass production techniques. GRFF did not sell in large quantities. It did not maintain a distributor network, but sold only through its own four sales representatives.

GRFF was attractive to petitioner because its acquisition would provide an addition to the broad line of products that petitioner was attempting to assemble and would provide an immediate competitive advantage in that area. The fact that GRFF's product was somewhat outmoded did not detract from its desirability.

Petitioner commenced negotiations for the acquisition of GRFF in July of 1968 with the shareholders...

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