Aeroquip-Vickers, Inc. v. C.I.R.

• Decision Date: 20 October 2003
• Docket Number: No. 01-2741.,01-2741.
• Citation: 347 F.3d 173
• Parties: AEROQUIP-VICKERS, INC. and Subsidiaries, f/k/a Trinova Corp. and Subsidiaries, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Sixth Circuit

347 F.3d 173

AEROQUIP-VICKERS, INC. and Subsidiaries, f/k/a Trinova Corp. and Subsidiaries, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 01-2741.

United States Court of Appeals, Sixth Circuit.

Argued: April 30, 2003.

Decided and Filed: October 20, 2003.

Petition for Rehearing Denied En Banc: January 21, 2004. Pursuant to Sixth Circuit Rule 206

ARGUED: Frank P. Cihlar, (argued and briefed), Joel L. McElvain (briefed), UNITED STATES DEPARTMENT OF JUSTICE, APPELLATE SECTION, TAX DIVISION, Washington, D.C., for Respondent-Appellant.

Frederick E. Henry, III (briefed), Robert S. Walton (briefed), Thomas V.M. Linguanti, (argued and briefed), BAKER & McKENZIE, Chicago, Illinois, for Petitioner-Appellee.

Before: CLAY and GIBBONS, Circuit Judges; DUGGAN, District Judge.^*

GIBBONS, J., delivered the opinion of the court, in which DUGGAN, D. J., joined. CLAY, J. (pp. 19-41), delivered a separate dissenting opinion.

OPINION

JULIA SMITH GIBBONS, Circuit Judge.

In 1986, petitioner-appellee Aeroquip-Vickers, Inc. (formerly known as Trinova Corporation, and operating as the Libbey-Owens-Ford Company (LOF) at the time), transferred all of its assets relating to a glass manufacturing business, including property for which it had previously claimed investment tax credits (ITCs) under former 26 U.S.C. § 38 (Section 38 property), into a wholly-owned subsidiary, LOF Glass, Inc. (LOF Glass). LOF then transferred LOF Glass to one of its shareholders, Pilkington Holdings, in return for Pilkington Holdings' shares in LOF. LOF treated this transaction as a corporate reorganization under 26 U.S.C. § 368(a)(1)(D) and accordingly did not recognize any gain or loss from the exchange on the consolidated federal income tax return for 1986 that it filed together with LOF Glass. LOF also did not report any recaptured ITCs from the transaction, as would be required by former 26 U.S.C. § 47(a)(1) upon the disposition of Section 38 property before the end of the property's estimated useful life.

In 1993, the Commissioner of Internal Revenue (CIR) asserted a deficiency against LOF for LOF's failure to include ITC recapture in income under former 26 U.S.C. § 47(a)(1) on its 1986 consolidated tax return. Trinova petitioned the United States Tax Court for a redetermination of the deficiency. The Tax Court held that neither the transfer of the property from LOF to LOF Glass nor the change in ownership of LOF Glass was a disposition of Section 38 property under 26 U.S.C. § 47, and that Trinova thus had no recapture obligations. CIR appealed. For the reasons set forth below, we reverse the decision of the Tax Court.

I.

The facts are not disputed. Pursuant to Tax Court Rule 91(a), the parties submitted a Stipulation of Facts, which the Tax Court summarized as follows:

Petitioner, an accrual basis taxpayer... changed its name to Trinova from the Libbey-Owens-Ford Company (LOF) on July 31, 1986. Petitioner timely filed a consolidated Federal income tax return with certain of its subsidiaries for the years at issue with the Internal Revenue Service Center, Cincinnati, Ohio, or the Internal Revenue Service office in Toledo, Ohio. Petitioner was engaged in the fluid power and plastics businesses and the manufacture of glass. The glass business was referred to as "LOF Glass Division."

One of LOF's largest shareholders was Pilkington Brothers (Pilkington), an English company, which owned 29 percent of petitioner's common stock through its wholly owned U.S. subsidiary, Pilkington Holdings, Inc. (Pilkington Holdings). Two of petitioner's fourteen directors were associated with Pilkington. In late 1985, Pilkington approached LOF and began negotiations concerning the possibility of acquiring the glass business.

Earlier that year, on July 25, 1985, the board of directors of LOF approved the transfer of the glass business to a wholly owned subsidiary for valid business reasons. On February 19, 1986, LOF Glass, Inc. was incorporated as a wholly-owned subsidiary of LOF. On March 6, 1986, a "Transfer and Assumption Agreement," amended on April 25, 1986, transferred to LOF Glass, Inc., all assets associated with the LOF Glass Division, including inventories and receivables, effective retroactively to February 19, 1986. These assets also included section 38 assets upon which LOF had previously claimed ITCs. Petitioner took no formal action contemplating the liquidation of LOF Glass, Inc., in the event that the acquisition by Pilkington did not take place.

On March 7, 1986, LOF, Pilkington, and Pilkington Holdings entered into an agreement, amended on April 28, 1996, whereby LOF would transfer all of its shares of LOF Glass, Inc., to Pilkington Holdings in exchange for all of the shares of petitioner held by Pilkington Holdings. On April 28, 1996, Pilkington Holdings exchanged 4,064,550 shares of LOF for the shares of LOF Glass, Inc. LOF Glass, Inc., continued to operate the glass business as a subsidiary of Pilkington Holdings and used the section 38 assets in its trade or business.

The parties have stipulated that petitioner recognized no gain or loss upon the transaction whereby its glass business was transferred to LOF Glass, Inc., pursuant to the provisions of section 351 or sections 354, 355, and 368(a)(1)(D) (except as required by such sections or section 357(c)), and that pursuant to section 355 neither petitioner nor Pilkington Holdings recognized any gain or loss upon the exchange of LOF Glass, Inc., shares for the LOF shares.

Before February 19, 1986, income, deductions, and credits with respect to the LOF Glass Division were included in petitioner's return. From February 19, 1986, through April 28, 1986, deductions and credits with respect to LOF Glass, Inc. (the subsidiary), were included as part of petitioner's consolidated return. After April 28, 1986, LOF Glass, Inc., was no longer part of petitioner, petitioner's affiliated group, or petitioner's consolidated Federal income tax return.

On its 1986 consolidated return, petitioner did not include any amount of ITC recapture with respect to the LOF Glass, Inc., section 38 assets. Respondent determined that a $5,718,749 ITC recapture arose from the April 1986 transaction. Petitioner does not dispute the amount of the ITC recapture....

On November 26, 1993, CIR issued a notice of deficiency to Trinova, stating that Trinova had understated its tax liabilities on the consolidated income tax returns that it had filed with its subsidiaries between 1985 and 1988. On February 18, 1994, Trinova filed a petition with the Tax Court contesting the deficiencies, including CIR's recapture of ITCs under 26 U.S.C. § 46. On February 27, 1997, the Tax Court found in favor of Trinova on the issue of the recapture of the ITCs. On October 1, 2001, the Tax Court entered a decision disposing of all claims of all parties. CIR timely filed a notice of appeal.

II.

The Tax Court's application of law to the fully stipulated record is reviewed de novo. See Friedman v. Comm'r, 216 F.3d 537, 541 (6th Cir.2000).

Under former 26 U.S.C. §§ 38 and 46, a taxpayer who acquired certain machinery and equipment for use in its trade or business (Section 38 property) was allowed a credit against its income tax liability in an amount equal to a percentage of his investment (the ITC). However, under former 26 U.S.C. § 47, the ITC was limited to property that the taxpayer used in its trade or business for most of the property's useful life. If the taxpayer disposed of Section 38 property before the end of the useful life, then the taxpayer was required to recapture the ITC and increase its tax liability. See 26 U.S.C. § 47(a)(1). The stated purpose of this provision was "[t]o guard against a quick turnover of assets by those seeking multiple credit." S.Rep. No. 1881, 87th Cong., 2d Sess. 11 (1962), U.S. Code Cong. & Admin. News at 3297, 3320.

Determining that Trinova was not liable for ITC recapture, the Tax Court emphasized that "the transactions herein took place in the consolidated return context." Section 1.1502-3(f)(2)(i) of the Consolidated Return Regulations (CRR) states that "a transfer of section 38 property from one member of the group to another member of such group during a consolidated return year shall not be treated as a disposition or cessation within the meaning of section 47(a)(1)." Defending the Tax Court's application of this provision to the facts in this case, Aeroquip-Vickers observes that "[a]fter [LOF] transferred the LOF Glass Division business ... to LOF Glass including some section 38 property, LOF Glass continued to use the section 38 property while a member of the [LOF] affiliated group," and thus asserts that the "transfer of the section 38 property to LOF Glass... was a non-event under section 47; there was no `disposition' of section 38 property." In addition, Aeroquip-Vickers argues that "this non-event for section 37 purposes did not metamorphose into an ITC recapture event merely because LOF glass ultimately left the [LOF] affiliated group" since "LOF Glass continued to use the section 38 property up to and following the time that LOF Glass left the [LOF] affiliated group." Aeroquip-Vickers thus claims that "there would be no recapture event unless or until LOF Glass disposed of the section 38 property." (emphasis in brief).

In support of its decision, the Tax Court relied upon CRR § 1.1502-3(f)(3), which provides the following examples:

Example (1). P, S, and T file a consolidated return for calendar year 1967. In such year S places in service section 38 property having an estimated useful life of more than 8 years. In 1968, P, S, and T file a consolidated return and in such year S sells such property to T. Such sale will not cause section 47(a)(1) to apply.

* * *

Example (3). Assume the same facts as in example (1), except that P, S, and T continue to file consolidated returns through 1971 and in such year T disposes of the property to individual A....