Central Tablet Manufacturing Co. v. United States

• Decision Date: 12 July 1973
• Docket Number: No. 72-1582.,72-1582.
• Parties: CENTRAL TABLET MANUFACTURING COMPANY, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Sixth Circuit

481 F.2d 954 (1973)

CENTRAL TABLET MANUFACTURING COMPANY, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

No. 72-1582.

United States Court of Appeals, Sixth Circuit.

Argued December 5, 1972.

Decided July 12, 1973.

COPYRIGHT MATERIAL OMITTED

David English Carmack, Atty., Tax Div., Dept. of Justice, for defendant-appellant ; Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, William A. Friedlander, Attys., Tax Div., Dept. of Justice, Washington, D. C., on brief; William W. Milligan, U. S. Atty., of counsel.

Larry H. Snyder, Chamblin, Snyder & Casey, Columbus, Ohio, for plaintiff-appellee.

Before McCREE and KENT,^* Circuit Judges, and McALLISTER, Senior Circuit Judge.

McCREE, Circuit Judge.

Section 337¹ of the Internal Revenue Code of 1954, as amended, has been judicially interpreted to provide for nonrecognition of a capital gain realized by a corporate taxpayer upon receipt of fire insurance proceeds paid after the destruction of property, if both the fire and payment occur within a 12-month period after the adoption of a plan of complete liquidation. This appeal requires us to determine whether the involuntary conversion (which equates with a sale or exchange of the property for purposes of § 337) occurs when the property is destroyed or when the policy proceeds are received because this taxpayer adopted a plan of complete liquidation after a fire but before receipt of the insurance proceeds. In an action for refund of $81,732.39 in taxes paid under protest, the district court determined that the involuntary conversion did not occur until the insurance proceeds had been paid. We hold that the conversion took place at the time the property was destroyed and reverse the judgment of the district court.

Appellee Central Tablet Manufacturing Company was an Ohio corporation with offices and manufacturing facilities in Columbus, Ohio. Until 1965 it employed a sizable labor force and was a profitable manufacturer of writing tablets, school supplies, art materials, and related articles. On August 13 of that year, taxpayer's production and maintenance employees went on strike. While the strike was in progress, an accidental fire on September 10, 1965, extensively damaged or destroyed the greater part of appellee's equipment, inventory, and building. Taxpayer, at the time of the fire, carried both fire and business interruption insurance, and timely notified the insurance carrier of the loss.

Although the insurance carrier questioned neither the validity of the insurance contracts nor the fulfillment of the conditions for payment thereunder,² it did dispute the amount to be paid under each policy.³ Negotiations between the taxpayer and the insurer began on November 1, 1965, to adjust the payments due under each policy. These efforts culminated in an agreement on the building claim on May 20, 1966 and on the personal property and other claims on August 25 of the same year.⁴ However, on May 14, 1966, six days before the first settlement and a full nine months after the fire, the shareholders of Central Tablet voted to dissolve the corporation and to liquidate its assets. Within the succeeding year, all corporate assets were collected, debts were paid, liquidating distributions were made to the shareholders, and, on May 3, 1967, a reserve was deposited in trust for the shareholders in the Ohio National Bank of Columbus, Ohio to await payment of final debts in completion of the liquidation.

As an accrual-basis taxpayer, appellee treated the gain realized from the fire insurance proceeds as nonrecognizable under IRC § 337. However, the Commissioner of Internal Revenue determined that the taxpayer had not qualified for this treatment because the shareholder liquidation vote came after the fire, which the Commissioner regarded as the time of conversion and thus of the "sale or exchange" to which § 337 refers. The taxpayer paid the deficiency assessed by the Commissioner and initiated a timely refund suit in the district court.

The district court, recognizing that this Circuit had not previously decided when an involuntary conversion occurs for purposes of § 337, followed the holding of the Eighth Circuit in United States v. Morton, 387 F.2d 441 (8th Cir. 1968), and entered judgment in favor of the taxpayer. The Government has appealed.

It is important at the outset to comment upon an uncontested issue. The Government does not now contest the treatment of a fire loss as a "sale or exchange" under § 337, although this is contrary to its position prior to 1964. Shortly after the passage of the Internal Revenue Act of 1954, the Commissioner of Internal Revenue, through Rev.Rul. 56-372, flatly stated that a casualty loss was not a sale within the meaning of § 337.⁵ This position was vigorously and consistently, although unsuccessfully, advocated before the court of claims⁶ and the Fourth Circuit.⁷ But in 1964, in Rev.Rul. 64-100, the Commissioner finally capitulated to the weight of mounting authority by revoking Rev.Rul. 56-372 and adopting the prevailing judicial view.⁸

The sole issue before us is on what date, for purposes of § 337, does the involuntary conversion that equates with the "sale and exchange" occur when insured capital assets are destroyed by fire. For the reasons hereinafter stated, we hold that the date the fire occurs is the date on which the conversion takes place for purposes of determining the applicability of § 337. Accordingly, since the appellee failed to adopt a plan of liquidation before the fire occurred, it does not qualify for nonrecognition of the gain from insurance proceeds.

The taxpayer insists that in this case, the involuntary conversion by fire that equates with a sale or exchange did not occur until the insurance proceeds were finally paid. He relies on United States v. Morton, supra. The Government, on the other hand, contends that the date of the fire should be regarded as the date of "sale."

We respectfully decline to follow Morton. In that case the Eighth Circuit analogized the involuntary conversion to a commercial sale where "the consideration is normally money which is readily and presently available for use by the holder or else comparable property which is of immediate benefit to the holder." 387 F.2d at 447-48. It determined that the "sale" could only be concluded when the taxpayer could specifically quantify the consideration it would receive, either by judgment or agreement. Id. However, this view misapprehends the purpose of § 337.

The legislative history indicates that § 337 was enacted to establish an easy-to-follow and well-defined corporate procedure by which the capital gains realized in liquidation sales would not be taxed to the corporation, but only to the shareholders upon distribution to them of the proceeds as liquidating dividends. In the ten years preceding the adoption of the Internal Revenue Act of 1954, two Supreme Court cases created considerable confusion concerning the way in which a corporation could escape taxation of gains under IRC § 22(a) (1939), from the sale of all its assets after a decision to liquidate the business. In Commissioner of Internal Revenue v. Court Holding Co., 324 U.S. 331, 65 S. Ct. 707, 89 L.Ed. 981 (1945), the Supreme Court upheld the tax court's determination that the corporation's breaking off negotiations to sell its only asset, an apartment building, and its subsequent conveyance of the building as a liquidating dividend to its sole shareholders, a husband and wife, who later sold it to the same persons with whom the corporation had been negotiating and reduced the sale price by the $1,000 down payment given to the corporation, "showed a sale by the corporation rather than by the stockholders . . . ." 324 U.S. at 332, 65 S.Ct. at 708. Although the court of appeals had reversed the tax court because it drew different inferences from the undisputed facts, Justice Black, in reiterating that findings of the tax court are binding on appellate courts, reasoned that

the incidence of taxation depends upon the substance of a transaction. The tax consequences which arise from gains from a sale of property are not finally to be determined solely by the means employed to transfer legal title. Rather, the transaction must be viewed as a whole, and each step, from the commencement of negotiations to the consummation of the sale, is relevant. . . . To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress. 324 U.S. at 334, 65 S.Ct. at 708.

Five years later in United States v. Cumberland Public Service Co., 338 U.S. 451, 70 S.Ct. 280, 94 L.Ed. 251 (1950), Justice Black, again speaking for the majority, this time upheld a court of claims determination that the corporation's shareholders had properly negotiated the sale of corporate assets distributed to them in kind in a partial liquidation without incurring the corporate tax liability of IRC § 22(a).

Although different outcomes resulted, there are many similarities in the two cases. In both Court Holding and Cumberland, the objective was the same: avoidance of corporate taxation. There was an offer to buy made to each corporation before negotiations with the shareholders commenced. The corporate assets were distributed in kind to the shareholders in both instances. Both sets of shareholders intended to sell the assets immediately upon receipt. Both sets of shareholders received all the proceeds of the sale.

The only significant difference appears...