Aetna Casualty and Surety Co. v. United States

• Decision Date: 15 October 1975
• Docket Number: Civ. No. H-131.
• Citation: 403 F. Supp. 498
• Parties: The AETNA CASUALTY AND SURETY COMPANY, for itself and as successor by merger to the Aetna Casualty and Surety Company v. UNITED STATES of America.
• Court: U.S. District Court — District of Connecticut

403 F. Supp. 498

The AETNA CASUALTY AND SURETY COMPANY, for itself and as successor by merger to the Aetna Casualty and Surety Company v. UNITED STATES of America.

Civ. No. H-131.

United States District Court, D. Connecticut.

October 15, 1975.

COPYRIGHT MATERIAL OMITTED

William G. Delana, J. Danford Anthony, Jr., Paul F. McAlenney, Hartford, Conn., for plaintiff.

Jerome Fink, and Robert M. Greco, Trial Attys., Tax Div., Dept. of Justice, Washington, D. C., Henry S. Cohn, Asst. U. S. Atty., Hartford, Conn., for defendant.

MEMORANDUM OF DECISION

BLUMENFELD, District Judge.

This is a tax refund suit involving the complex reorganization provisions of the Internal Revenue Code. The plaintiff seeks over $4.4 million dollars, plus interest, which it claims to have overpaid in taxes. A review of the background of this case will make this claim more understandable. The parties have stipulated to most (and disagree as to none) of the material facts and have entered cross-motions for summary judgment.

I.

Aetna Life Insurance Co. (Aetna Life) is a Connecticut company that writes and sells life, accident, and health insurance throughout this country and Canada. Until December 29, 1964, the Aetna Casualty and Surety Co. (Old Aetna) was a Connecticut company that wrote and sold liability, fire, theft, property damage, and surety insurance. Aetna Life had owned more than 50 per cent of Old Aetna's 7,000,000 shares of common voting stock continuously since 1958. By December 29, 1964, Aetna Life owned some 4,312,535 shares (61.61 per cent).

A.

The Life Insurance Company Income Tax Act of 1959, Pub.L.No. 86-69, § 2(a), 73 Stat. 112, substantially changed the manner in which life insurance companies are taxed. For present purposes it is only important to understand that one of the effects of that Act was to make Aetna Life's taxes depend in part upon its asset base: the larger its assets, the greater its taxes. See Int.Rev. Code of 1954, §§ 802(a)(1), (b), 804(a) (1), 805(a)(1), (b)(2)(B), (b)(4). Among Aetna Life's assets was its ownership of 61.61 per cent of the stock of Old Aetna.

Aetna Life understandably wished to remove this interest in Old Aetna from its asset base. The obvious way to accomplish such a purpose was to distribute the assets to its shareholders.¹ In the context of insurance company taxation, however, such a route was problematical. The Int.Rev.Code of 1954, § 802 (b)(3) makes certain portions of "distributions to shareholders" taxable to the life insurance company. Because a distribution of Old Aetna stock apparently would have come within § 802 (b)(3), Aetna Life sought to have the law amended. In 1964 it succeeded. Act of Sept. 2, 1964, Pub.L.No. 88-571, § 4(a)(2), 78 Stat. 859, added, inter alia, the language that is now Int.Rev. Code of 1954, § 815(f)(3)(B). The language provided two avenues by which Aetna Life could distribute its Old Aetna holdings without tax consequences to itself; the routes were circuitous and narrowly defined:

"(f) Distribution defined.—For purposes of this section, the term `distribution' includes any distribution in redemption of stock or in partial or complete liquidation of the corporation, but does not include—

. . . . . .

(3) any distribution after December 31, 1963, of the stock of a controlled corporation to which section 355 applies, if such controlled corporation is an insurance company subject to the tax imposed by section 831² and if—

. . . . . .

(B) control has been acquired after December 31, 1957—

(i) in a transaction qualifying as a reorganization under section 368 (a)(1)(B), if the distributing corporation has at all times since December 31, 1957, owned stock representing not less than 50 percent of the total combined voting power of all classes of stock entitled to vote, and not less than 50 percent of the value of all classes of stock, of the controlled corporation, or

(ii) solely in exchange for stock of the distributing corporation which stock is immediately exchanged by the controlled corporation in a transaction qualifying as a reorganization under section 368(a)(1)(A) or (C), if the controlled corporation has at all times since its organization been wholly owned by the distributing corporation and the distributing corporation has at all times since December 31, 1957, owned stock representing not less than 50 percent of the total combined voting power of all classes of stock entitled to vote, and not less than 50 percent of the value of all classe of stock of the corporation the assets of which have been transferred to the controlled corporation in the section 368(a)(1)(A) or (C) reorganization."

In order to fit within this language,³ Aetna Life proposed to organize the Farmington Valley Insurance Co. (Farmington Valley), a wholly owned shell subsidiary. Aetna Life would issue 13,300,000 shares of its voting common stock and exchange them for all 1000 shares of Farmington Valley. Then, pursuant to a reorganization plan approved in November 1964 by the shareholders of Farmington Valley and Old Aetna,⁴ Farmington Valley would exchange its sole assets—the Aetna Life stock—for the voting common stock held by the Old Aetna shareholders in the ratio of 1.9 shares of Aetna Life stock for each share of Old Aetna stock. The Aetna Life stock received by Aetna Life in return for its 61.61 per cent holding in Old Aetna would be retired. The Old Aetna stock received by Farmington Valley, the surviving company, would be cancelled. Farmington Valley would change its name to Aetna Casualty and Surety Co. (New Aetna) and, by operation of Connecticut's merger law, succeed to all of the assets and liabilities of Old Aetna. The management, business, and all of the attributes of Old Aetna would continue under the aegis of New Aetna. Aetna Life would then distribute the 1000 shares of New Aetna (formerly Farmington Valley) by putting them into a trust for the benefit of all of Aetna Life shareholders. Evidence of a proportional beneficial interest in the trust would be "stapled" to each Aetna Life share so that both the Aetna Life share and its proportionate beneficial interest in the trust of New Aetna shares would always be held by the same owner.

After having received approval from the Connecticut Insurance Commissioner and a ruling from the Internal Revenue Service (IRS) that the "acquisition by Farmington Valley of substantially all of the assets and assumption of the liabilities of Old Aetna in exchange solely for voting stock of Aetna Life will constitute a reorganization within the meaning of section 368(a)(1)(C) of the Code,"⁵ the three companies carried out the plan described above on December 29, 1964. As the IRS found it to fit within the new exception to § 815, the nontaxability of the transaction desired by the parties came to pass.⁶

B.

During 1964 Old Aetna and New Aetna incurred total net operating losses of $7,292,741. Of these, $7,253,144 were attributable, on a pro rata basis,⁷ to Old Aetna; $39,597 of the losses were attributable to New Aetna.⁸ During 1965 New Aetna incurred net operating losses of $11,594,322. Under Int.Rev.Code of 1954, § 172 operating losses of a taxpayer may be "carried back" to reduce its taxable income earned during the three preceding years.⁹ The IRS allowed Old Aetna, apparently in its final return, to carry back its $7,253,144 share of 1964 losses to offset its 1961-62 and part of its 1963 taxable income. But it disallowed any carryback of New Aetna's 1964 and 1965 losses to offset the remainder of Old Aetna's 1963 income. The parties agree that if the carryback were allowed, New Aetna would be entitled to a refund of $4,071,655.21, plus the $395,975.38 of deficiency interest paid with respect thereto, plus legal interest on both such amounts.

The grounds of the IRS disallowance of the carryback are set forth in its technical advice memorandum of August 28, 1968 (Exh. J to Stipulation of Facts). The IRS relied on Int.Rev.Code of 1954, § 381, which is first concerned with "carryovers" in certain corporate acquisitions:

"(a) General rule. — In the case of the acquisition of assets of a corporation by another corporation —

(1) This deals with the basis of assets distributed.

(2) in a transfer to which section 361 (relating to nonrecognition of gain or loss to corporations) applies, but only if the transfer is in connection with a reorganization described in subparagraph (A), (C), (D) . . . or (F) of section 368(a)(1),

the acquiring corporation shall succeed to and take into account, as of the close of the day of distribution or transfer, the items described in subsection (c) of the distributor or transferor corporation, subject to the conditions and limitations specified in subsections (b) and (c)."

Section 381 also deals specifically with "carrybacks" as follows:

"(b) Operating rules. — Except in the case of an acquisition in connection with a reorganization described in subparagraph (F) of section 368(a)(1)—

. . . . . .

(3) The corporation acquiring property in a distribution or transfer described in subsection (a) shall not be entitled to carry back a net operating loss for a taxable year ending after the date of distribution or transfer to a taxable year of the distributor or transferor corporation."

As it stated in its earlier ruling letter, the IRS contends that the transaction described above was a C reorganization,¹⁰ and that therefore § 381(b)(3) excludes New Aetna, the "corporation acquiring property in a . . . C reorganization, as described in subsection (a)," from carrying back "a net operating loss for a taxable year ending after the date of . . . the reorganization to a taxable year of" Old Aetna the transferor.

New Aetna, the plaintiff, makes several distinct arguments to support its position that the IRS is wrong and that it is indeed entitled to the carryback it seeks. These are described in the sections below.

To determine whether losses sustained by New Aetna after the merger may be carried...