Bhada v. Comm'r of Internal Revenue

• Decision Date: 05 November 1987
• Docket Number: 22589-86.,Docket. Nos. 22588-86
• Citation: 89 T.C. No. 67,89 T.C. 959
• Parties: ROHINTON K. BHADA AND PATRICIA A. BHADA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentEDWARD J. CAAMANO AND JANICE W. CAAMANO, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

89 T.C. 959

89 T.C. No. 67

ROHINTON K. BHADA AND PATRICIA A. BHADA, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, RespondentEDWARD J. CAAMANO AND JANICE W. CAAMANO, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket. Nos. 22588-86

22589-86.

United States Tax Court

Filed November 5, 1987.

Ps were shareholders of M. M was a domestic corporation, and MI was its wholly-owned foreign subsidiary. The boards of directors of M and MI decided to take advantage of the lower income tax rates available in the areas outside the United States in which MI operated by changing the corporate structure so that MI would become the parent corporation and M the subsidiary. To effect the change, MI gave 30 million shares of its common stock plus $0.35 per share (a total of $10,500,000) to the shareholders of M, including Ps, in return for 30 million shares of the common stock of M. After the exchange, MI held approximately 68 percent of the voting power in M and the former holders of M common stock who participated in the exchange owned approximately 90 percent of the voting power in MI.

HELD, the shares of MI stock received by Ps do not constitute ‘property‘ within the meaning of I.R.C. section 304(a)(2)(A). John P. Carroll, Jr., Richard M. Fabbro and Leslie J. Hoffman for the petitioners.

Alfred C. Bishop, Jr., for the respondent.

OPINION

NIMS, JUDGE:

This matter is before the Court on the parties' Cross-Motions for Partial Summary Judgment pursuant to Rule 121. ¹ The parties have complied with the requirements of Rule 121, and we find that a partial summary judgment is appropriate in this case. The issue raised by each motion is whether the shares of International common stock received by petitioners in exchange for McDermott common stock constitute ‘property‘ within the meaning of section 304(a)(2)(A).

All the facts have been agreed upon (‘stipulated‘) for purposes of these Rule 121 motions.

Petitioners Rohinton and Patricia Bhada were residents of Alliance, Ohio, and petitioners Edward and Janice Caamano were residents of New Orleans, Louisiana, when the petitions in these cases were filed. There are approximately 87 docketed cases in this Court involving the same transaction, and these two cases have been identified as test cases for the purpose of resolving the preliminary issue concerning the applicability of section 304 to the transaction in question.

McDermott, Inc. (McDermott), was a Delaware corporation at all relevant times. From 1959 until December 10, 1982, McDermott was the parent corporation to a group of corporations hereinafter referred to as the McDermott Group. From 1959 until December 10, 1982, McDermott International, Inc. (International), was a wholly-owned subsidiary of McDermott and a controlled foreign corporation within the meaning of section 957.

Pursuant to a plan of reorganization adopted on October 28, 1982, by the boards of directors of McDermott and International, International made an offer to exchange cash and shares of its own stock (International Common) for shares of the common stock of McDermott (McDermott Common). International distributed a prospectus dated November 24, 1982 (the Prospectus), which stated the terms and conditions on which the offer was made.

The Prospectus stated:

The principal purpose of the reorganization is to enable the McDermott Group to retain, reinvest and redeploy earnings from operations outside the United States without subjecting such earnings to United States income tax. This will enable the McDermott Group to compete more effectively with foreign companies by taking advantage of additional opportunities for expansion which require long-term commitments, the redeployment of assets and the reinvestment of earnings. The reorganization will also result in direct shareholder participation in the accumulated and future profits of International earned abroad rather than shareholder participation in such foreign earnings only after they are first distributed to the Delaware Company and subjected to corporate income tax at a rate substantially higher than the average rate prevailing in the areas in which International operates. Finally, the reorganization will permit International to invest its accumulated foreign earnings in the United States without Federal income tax being imposed on the Delaware Company upon the making of such investment.

* * *

The aggregate amount reported by [McDermott] as Subpart F income of International in the five years ended March 31, 1982 was approximately $20,000,000 and the aggregate United States income tax imposed thereon was approximately $9,000,000. * * * If, however, the business of International continues in its present form and at levels now anticipated by management for the five succeeding years, it is anticipated that the aggregate Subpart F income generated by International will be approximately $585,000,000 for such years and the aggregate United States income tax imposed on that total amount would (at currently prevailing rates) be approximately $220,000,000. In the opinion of Davis Polk & Wardwell, United States Counsel to International, the reorganization, under present laws and regulations, will enable the McDermott Group to avoid future Subpart F income tax costs because, after the exchanges pursuant to the Offer, International will no longer be a CFC [controlled foreign corporation].

Under the terms of the offer, International was to exchange one share of International Common plus $0.35 for each outstanding share of McDermott Common. The offer was conditioned upon the tendering of a minimum of 22 million shares of McDermott Common. International also retained the right to refuse to accept more than 30 million shares of McDermott Common.

On December 10, 1982, International accepted, pursuant to the terms of the Offer, all shares of McDermott Common tendered by each shareholder holding 99 or fewer of such shares and accepted a portion of all the shares of McDermott Common tendered by each shareholder holding 100 or more of such shares, as was determined on the terms concerning proration stated in the Prospectus. International acquired 30 million shares of McDermott Common for which it gave $10,500,000 and 30 million shares of International Common. As a result of the exchange, International held approximately 68 percent of the voting power in McDermott, and former holders of McDermott Common who participated in the exchange held approximately 90 percent of the voting power in International.

Petitioners participated in the December, 1982, transactions. In response to the Offer, petitioners Rohinton and Patricia Bhada tendered to International 26 shares of McDermott Common and received in return 26 shares of International Common and $9.10 in cash. Petitioners Edward and Janice Caamano tendered to International 50 shares of McDermott Common and received in return 50 shares of International Common and $17.50 in cash. On December 10, 1982, the fair market value of one share of International Common was $19.

Section 304(a)(2) provides:

(2) ACQUISITION BY SUBSIDIARY. — For purposes of sections 302 and 303, if —

(A) in return for property, one corporation acquires from a shareholder of another corporation stock in such other corporation, and

(B) the issuing corporation controls the acquiring corporation,

then such property shall be treated as a distribution in redemption of the stock of the issuing corporation.

Section 304(c) provides, in part, that control, for purposes of section 304, means ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote, or at least 50 percent of the total value of shares of all classes of stock.

If section 304(a)(2) applies to the December, 1982, transaction, the International Common and cash received by petitioners must be treated as a distribution in redemption of their stock in McDermott, and it will be necessary to apply section 302 to determine the character of the amounts received by petitioners in International Common and cash. The parties have agreed that the cash received by petitioners is property for purposes of section 304(a)(2) and that if section 304 does not apply to the International Common received by petitioners, the tax consequences of the receipt of that stock will then be governed by section 1001. ²

Section 304 does not apply to the International Common received by petitioners unless this stock was ‘property‘ for purposes of section 304(a)(2). ³ The term ‘property‘ is defined in section 317(a), which provides:

For purposes of this part, the term ‘property‘ means money, securities, and any other property; except that such term does not include stock in the corporation making the distribution (or rights to acquire such stock).

The receipt of stock of a corporation which is not stock of the distributing corporation is ‘property.‘ See H. Rept. No. 1337, 83d Cong., 2d Sess. A 100 (1954).

Respondent argues that the true nature of the transaction between International and petitioners was an exchange of International Common for McDermott Common rather than a distribution by International of its stock in exchange for McDermott Common. It is respondent's position that the term ‘distribution‘ in section 317(a) refers only to a distribution by a corporation with respect to its stock to its shareholders in their capacity as shareholders. Because International gave its stock to McDermott's shareholders and not to its own shareholders, respondent maintains that there was no distribution as defined in section 317(a). We disagree.

The terms ‘property‘ and ‘distribution‘ are defined in section 317 for purposes of Part I of Subchapter C of the Internal Revenue Code. Section 317(a); Anderson v. Commissioner, 67 T.C. 522, 561 (1976), affd. per curiam 583 F.2d 953 (7th Cir. 1978). Respondent finds support for his definition of the term ‘distribution‘ by asserting that the term ‘distribution‘ as it...