Russell v. C.I.R., s. 86-1679

• Decision Date: 27 October 1987
• Docket Number: Nos. 86-1679,86-1680,s. 86-1679
• Citation: 832 F.2d 349
• Parties: -5903, 87-2 USTC P 9586 Walter J. & Mary Ann RUSSELL (86-1679), Cannonsburg Skiing Corporation (formerly Brown-Schaefer Corporation), Transferee of the assets of Cannonsburg Skiing Corporation, Transferor (86-1680), Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 349

832 F.2d 349

60 A.F.T.R.2d 87-5903, 87-2 USTC P 9586

Walter J. & Mary Ann RUSSELL (86-1679), Cannonsburg Skiing Corporation (formerly Brown-Schaefer Corporation) Transferee of the assets of Cannonsburg Skiing Corporation Transferor (86-1680), Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

Nos. 86-1679, 86-1680.

United States Court of Appeals Sixth Circuit.

Argued Aug. 25, 1987.

Decided Oct. 27, 1987.

Walter J. Russell, Grand Rapids, Mich., pro se.

Jean Owens, Acting Counsel, I.R.S., Michael L. Paup, Lead Counsel, Roger M. Olsen, Tax Div., Dept. of Justice, Washington, D.C., Jonathan S. Cohen, Raymond W. Hepper, James B. Mann (argued), for C.I.R.

Before MARTIN and BOGGS, Circuit Judges, and WISEMAN, ^* District Judge.

BOYCE F. MARTIN, Jr., Circuit Judge.

Walter J. Russell and Cannonsburg Skiing Corporation appeal the Tax Court's (T.C. Memo 1986-150) denial of their claim against the Commissioner. Taxpayers claim that they were wrongfully denied tax benefits when the Commissioner determined that a series of transactions by them constituted a complete liquidation under Section 332 of the Internal Revenue Code of 1954 (26 U.S.C.), that Section 334(b)(2) applied for purposes of calculating the basis of the corporation's assets, and that there was no reorganization under Section 368(a)(1) of the Code nor any tax-free contributions to capital under Section 351 of the Code.

On appeal, they raise three issues: (1) whether the Tax Court correctly categorized their transactions as a liquidation to which Section 332 and 334(b)(2) applied, thus denying the corporation an opportunity to carry back post-acquisition net operating losses to offset pre-acquisition income; (2) whether the Tax Court correctly held that the taxpayers failed to meet the requirements for a 368(a)(1) reorganization, and (3) whether the Tax Court correctly held that they did not meet the requirements of Section 351 for tax-free contributions.

The material facts in this case are not in dispute and have been stipulated by the parties.

The Cannonsburg Skiing Corporation (Old Cannonsburg) was formed in 1965. Its sole business was the operation of a full-service ski facility, located outside Grand Rapids, Michigan. Russell and Mary Ann Russell, husband and wife, resided in Grand Rapids, Michigan, at the time they filed their petition. Russell was a shareholder of Old Cannonsburg from 1967 until October 24, 1978, on which date he surrendered his 1,857 shares of Old Cannonsburg stock for 3,233.2 shares of Brown-Schaefer stock. As of October, 1977, Old Cannonsburg had 215,000 shares of authorized, common voting stock with a par value of one dollar per share. The outstanding stock was owned as follows:

NOTE: OPINION CONTAINS TABLE OR OTHER DATA THAT IS NOT VIEWABLE

On October 21, 1977, the owners of 98% of the Old Cannonsburg stock (the Goff Group), excluding Walter Russell, agreed to sell their shares to Paul W. Brown, Prentiss M. Brown, Jr., and Roy A. Schaefer (the Brown Group). This agreement contemplated that the Brown Group would form a corporation, 100% owned by them, to which all the rights and obligations of the stock purchase agreement would be assigned.

On February 6, 1978, the Brown Group formed Brown-Schaefer Corporation under the laws of the state of Michigan. The corporation's stock was owned one-third each by the three principals. Its only assets were funds provided by the Brown Group to be used as a down payment for the Old Cannonsburg stock. Pursuant to the October 21, 1977 Agreement, they assigned their rights and interests under the Agreement to their newly formed and wholly owned corporation.

On May 5, 1978, Brown-Schaefer purchased approximately 98% of Old Cannonsburg's outstanding shares and the Brown Group became the sole members of Old Cannonsburg's board of directors. From the date of closing until October 31, 1978, Old Cannonsburg was operated as a subsidiary of Brown-Schaefer. The remaining 2% of Old Cannonsburg was owned by Russell.

At the time Brown-Schaefer purchased its 98% interest, Russell was secretary and attorney for Old Cannonsburg as well as a member of the board of directors. Russell, however, was not actively involved in the management of Old Cannonsburg other than in his professional capacity as attorney-advisor.

During the negotiations that preceded the October 21, 1977 Agreement, the Brown Group attempted to purchase Russell's 2% interest in Old Cannonsburg. This offer to purchase was renewed at the time the 98% stock purchase was consummated. Because he desired to retain an equity interest in Old Cannonsburg as an investment, however, Russell declined the offer on both occasions.

On October 23, 1978, the board of directors of Old Cannonsburg adopted unanimously a plan of reorganization. Pursuant to this plan, Russell was advised by letter that Brown-Schaefer desired to acquire his shares in exchange for its shares. In part, the letter read as follows:

[R]ealizing that you have no desire to terminate your interest in ownership of the business operated by Cannonsburg Skiing Corporation, we hereby offer to trade you shares of Brown-Schaefer Corporation for your Cannonsburg Skiing Corporation common stock.

....

Failure to accept the offer will, of course, leave Brown-Schaefer Corporation free to accomplish its purpose through other means.

On October 24, 1978, Russell accepted Brown-Schaefer's offer and surrendered his 1,857 shares of Old Cannonsburg stock for 3,233.2 shares (approximately 7%) of Brown-Schaefer's outstanding common stock. As a result, Old Cannonsburg became a wholly-owned subsidiary of Brown-Schaefer on October 24, 1978.

On the same day, a special meeting of the board of directors of Brown-Schaefer adopted a Plan of Merger of Old Cannonsburg into Brown-Schaefer. Effective October 31, 1978, Old Cannonsburg was liquidated and merged into Brown-Schaefer, and Brown-Schaefer was renamed Cannonsburg Skiing Corporation (New Cannonsburg). Thereafter, New Cannonsburg continued to operate the same business at the same location as had been operated by Old Cannonsburg.

At the time of the merger, Old Cannonsburg had a basis of $1,295,150 in its fixed assets. Immediately after the liquidation and merger, New Cannonsburg reported a stepped-up cost basis of $3,587,201.

Old Cannonsburg filed its final, amended income tax return for the short tax year from May 31, 1978 through October 31, 1978. For the 2% stock interest received from Russell, the return did not reflect any realized gain, but treated the stock exchange as a reorganization under section 368(a)(1) under which no gain would be realized and no recapture reported. New Cannonsburg also attempted to carry back net operating losses incurred during its first year of operation to offset Old Cannonsburg's net operating income for the years at issue.

Russell's individual income tax return for 1978 reported no gain on the exchange of Old Cannonsburg stock for Brown-Schaefer stock. Russell maintains that the exchange was a reorganization, and, as such, no gain had to be reported.

On December 15, 1982, the Commissioner sent New Cannonsburg a notice of liability and sent Russell a statutory notice of deficiency. Russell and New Cannonsburg challenged these notices in Tax Court. Based on the stipulated facts, however, the Tax Court upheld all of the Commissioner's deficiency determinations. The plaintiffs now appeal that decision, raising the three issues noted at the outset of this opinion. For the reasons set out below, we affirm the Tax Court's decision.

We agree with the Tax Court that New Cannonsburg may not carry back its net operating loss to offset income earned in previous years by Old Cannonsburg. Section 381(b)(3) of the Internal Revenue Code provides that a transferee corporation may not carry back a net operating loss generated in the taxable year after the transfer to a taxable year of the transferor "except in the case of an acquisition in connection with a reorganization described in subparagraph (F) of Section 368(a)(1)."

It should be noted that during 1977 and 1978, the years in question here, the merger of a wholly-owned subsidiary into its parent, which satisfied the requirements of a liquidation under Section 332 and to which Section 334(b)(2) does not apply, also qualified as an F Reorganization for purposes of Section 381(b)(3). Performance Systems, Inc. v. United States, 382 F.Supp. 525 (M.D.Tenn.1973), aff'd per curiam, 501 F.2d 1338 (6th Cir.1974). Here, however, the requirements of a 334(b)(2) liquidation were clearly met: Brown-Schaefer acquired the stock of Old Cannonsburg by purchase, which was a taxable event to the Goff shareholders, the plan of liquidation was adopted within two years of the purchase, and New Cannonsburg received all the Old Cannonsburg property in one distribution. See Kansas Sand and Concrete, Inc. v. Commissioner, 462 F.2d 805 (10th Cir.1972). In fact, it is only because it met the requirements of section 334(b)(2) that New Cannonsburg was able to step up the basis of the assets as it did.

Before any reorganization can be found to have occurred, however, the "continuity of interest" doctrine must be satisfied. Without a continuity of proprietary interest, there...