Atlas Tool Co. v. Comm'r of Internal Revenue

• Decision Date: 27 April 1978
• Docket Number: Docket Nos. 7633-74—-7635-74.
• Citation: 70 T.C. 86
• Parties: ATLAS TOOL CO., INC., et al.,1 PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

70 T.C. 86

ATLAS TOOL CO., INC., et al.,1 PETITIONERS

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 7633-74—-7635-74.

United States Tax Court

Filed April 27, 1978.

Corporation A and corporation B were each wholly owned by S. Corporation A was the principal purchaser of corporation B's production. In connection with a plan to terminate corporation B's activities and rely on foreign suppliers, corporation A acquired for cash corporation B's operating assets. Corporation B then distributed all of its remaining assets to S and dissolved. Corporation B's operating assets were acquired to ensure corporation A's supply of goods, but corporation A hoped not to have to use them. No active use of the assets was made for approximately 3 months. However, after problems developed with the foreign suppliers, the assets were gradually placed into service in the same manner as they had been employed by corporation B. Held, the steps taken by the parties, including the liquidation of corporation B, were integral steps in a plan of reorganization described in sec. 368(a)(1)(D), I.R.C. 1954, and the distribution to S is taxed under sec. 356(a), I.R.C. 1954. Held, further, the distribution has the effect of a dividend within the meaning of sec. 356(a)(2), I.R.C. 1954, and S's gain is to be treated as a dividend to the extent of corporation B's earnings and profits. Held, further, as transferee of corporation B's assets, corporation A is liable for the tax liabilities of corporation B because under New Jersey law there was a de facto merger of the two corporations and because under New Jersey law corporation A was the mere continuation of corporation B. Held, further, corporation A is liable for accumulated earnings taxes for its taxable years in issue. John J. O'Toole and Edwin Fradkin, for the petitioners.

Marwin A. Batt, for the respondent.

SCOTT, Judge:

Respondent determined deficiencies in petitioners' Federal income taxes in the following amounts:

+-------------------------------------------------------+
                ¦Petitioner         ¦Docket  ¦TYE          ¦Deficiency  ¦
                +-------------------+--------+-------------+------------¦
                ¦                   ¦No.     ¦             ¦            ¦
                +-------------------+--------+-------------+------------¦
                ¦                   ¦        ¦             ¦            ¦
                +-------------------+--------+-------------+------------¦
                ¦Atlas Tool Co., Inc¦7633-74 ¦June 30, 1969¦$147,103.59 ¦
                +-------------------------------------------------------+
                

                                June 30, 1970 98,933.78
                Atlas Tool Co., Inc
                successor to
                Fletcher Plastics., Inc 7634-74 Nov. 30, 1968 14,985.42
                

                             Nov. 30, 1969 22,161.39
                                             Nov. 30, 1970 1,238.66
                Stephan Schaffan and
                Mildred Schaffan     7635-74 Dec. 31, 1970 232,121.36
                

After concessions by the parties, the following issues remain for our consideration:

(1) Whether a corporate distribution received by petitioner Stephan Schaffan in 1970 was a distribution in complete liquidation of Fletcher Plastics, Inc., treated under section 331, I.R.C. 1954,² or a distribution of money in pursuance of a plan of reorganization involving Fletcher Plastics, Inc., and Atlas Tool Co., Inc., treated in whole or in part as a dividend under section 356(a);

(2) In the latter case, whether the amount of a dividend under section 356(a) is measured by the earnings and profits only of Fletcher Plastics, Inc., or by those of Atlas Tool Co., Inc., as well;

(3) Whether Atlas Tool Co., Inc., is liable for the income tax deficiencies of Fletcher Plastics, Inc., at issue in this case; and

(4) Whether Atlas Tool Co., Inc., was formed or availed of for the purpose of avoiding the income tax with respect to its shareholder, Stephan Schaffan, by permitting its earnings and profits to accumulate instead of being distributed, within the meaning of section 532.

FINDINGS OF FACT

Some of the facts have been stipulated and are found accordingly.

Petitioners Stephan Schaffan and Mildred Schaffan filed a joint individual Federal income tax return for calendar year 1970, during which year they were husband and wife. At the time of filing their petition in this case, they each resided in New Jersey. Petitioner Atlas Tool Co., Inc. (hereinafter Atlas), filed corporate Federal income tax returns for its fiscal years ending June 30, 1969, and June 30, 1970. Fletcher Plastics, Inc. (hereinafter Fletcher), filed corporate Federal income tax returns for its fiscal years ending November 30, 1968, November 30, 1969, and November 30, 1970. At the time of filing its petitions in this case, Atlas maintained its principal place of business in Hillside, N. J.

Stephan Schaffan's father organized the Atlas Tool Co. as a sole proprietorship in 1924. The proprietorship manufactured tools, dies, jigs, and fixtures for metal forming, blanking, and stamping and produced certain specialized equipment. Stephan Schaffan began working in the business in 1931. He became a partner in 1945. Beginning in 1945, the partnership became involved in manufacture and sales in the model railroad industry. It simultaneously phased out its manufacture of tools and dies for unrelated parties. After 1949 and to date, the company's efforts have been devoted almost exclusively to the hobby industry, including model railroads and model motoring.

After his father's death in 1948, Stephan Schaffan operated the business as a proprietorship until it was incorporated in 1949 as Atlas Tool Co., Inc. Stephan Schaffan has always been president and principal stockholder of Atlas. During the years in issue, he was the sole stockholder.

Prior to 1960, Atlas conducted design, manufacturing, assembly, and sales functions as an integrated operation. It manufactured principally track, switches, and accessories for model railroads. In 1960, Fletcher was incorporated by Stephan Schaffan, who became its president and sole stockholder. Atlas' plastic injection molding machines were transferred to Fletcher, and Fletcher then performed molding and production of subassemblies for Atlas. Thereafter, Atlas conducted only design, assembly and sales functions. Fletcher made only a few, isolated sales of goods to buyers other than Atlas. Atlas, however, purchased inventory from unrelated domestic and foreign manufacturers for inclusion in its sales line.

Fletcher's operations, its machinery, equipment, employees, books, and records, were located at 378 Florence Avenue, Hillside, N. J., in a building owned by West Shelton Realty Co., a corporation owned solely by Stephan Schaffan. Fletcher's machinery occupied the first floor of the building. This building also served as the main plant and offices of Atlas, which also leased its space from the realty company.

The operations of Atlas were housed in four buildings during the years in issue. The original building, 413 Florence Avenue, was acquired in 1948 and expanded twice between 1950 and 1952. The 378 Florence Avenue building was constructed in 1951 and expanded in 1959 and 1968. Two other buildings were constructed in 1961 and 1964. Stephan Schaffan owned the 413 Florence Avenue property personally. Aside from 378 and 413 Florence Avenue, the other buildings were owned by Atlas.

A fifth building was constructed by Atlas on land acquired from Stephan Schaffan in 1972. The need for additional space had become apparent about 1969, and the active planning for the building was begun in 1973. Construction was commenced in 1974, and Atlas received a certificate for occupancy on May 28, 1975. The total cost of the building, including mechanical equipment it contained, was $783,934. At least $533,412 of this amount was paid prior to March 15, 1975.

Atlas began purchasing components from foreign sources in 1959. It increased the amount and variety of these imported items throughout the 1960's, purchasing from companies in Germany, Italy, Yugoslavia, Austria, Japan, and Hong Kong. It found that these imports were cheaper than domestically manufactured goods and that their quality was good. Atlas experienced only occasional problems with the quality and shipping arrangements of its imports before 1970. Atlas became increasingly dependent on these imports. During its fiscal years ending June 30 in 1968, 1969, and 1970, imports were approximately 46.6 percent, 45 percent, and 47 percent, respectively, of Atlas' total purchases.

During the years in issue, Atlas normally employed irrevocable letters of credit to pay for its imports. It also used checks and sight drafts for small orders. The letters of credit were obtained through the First National State Bank of New Jersey in the amount of a purchase order and forwarded to the foreign manufacturer. The manufacturer was not required to begin production on the order until receipt of the letter of credit, but in fact Atlas' regular suppliers usually had already begun production when the letter was issued. The manufacturer was entitled to payment on the order, according to the terms of the letter of credit, upon placing the goods with the carrier. At that point, Atlas' account was charged for the payment and a debit notice was mailed to it. Atlas then received the goods in due course from the carrier, usually within 2 to 3 weeks. Until the manufacturer received payment, the letter of credit represented only a contingent liability. Payment was due only if and when the goods were shipped. However, the letter of credit served as security for the manufacturer while the order was prepared.

Dozens of individual letters of credit were outstanding over the course of any of the years in issue. They could be extended, and many were extended, during those years. During the calendar years 1968, 1969, and 1970, the total amounts of the letters of credit issued on behalf of Atlas were $991,250, $1,497,700, and $385,640, respectively. Fewer letters of credit were issued in 1970 because certain European suppliers were...