Central Tablet Manufacturing Co. v. United States

• Citation: 339 F. Supp. 1134
• Decision Date: 17 March 1972
• Docket Number: Civ. No. 69-116.
• Parties: CENTRAL TABLET MANUFACTURING COMPANY, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of Ohio

339 F. Supp. 1134

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

Civ. No. 69-116.

United States District Court, S. D. Ohio, E. D.

March 17, 1972.

Larry H. Snyder, Columbus, Ohio, for plaintiff.

Stephen Csontos, Department of Justice, Tax Division, Washington, D. C., for defendant.

OPINION AND ORDER

CARL B. RUBIN, District Judge.

This action, brought pursuant to Title 28 U.S.C. § 1346(a) (1) to recover taxes alleged to have been erroneously collected, comes before the Court for final decision on the stipulations of fact, exhibits, and briefs of the parties.

The uncontested facts in this case are as follows: Plaintiff, Central Tablet Manufacturing Company (hereinafter Central Tablet) was for many years prior to May 14, 1966, an Ohio corporation engaged in the manufacture and sale of writing tablets, school supplies, art materials and related items at its place of business in Columbus, Ohio. On August 13, 1965, a majority of Central Tablet's production and maintenance employees went on strike, thereby reducing production to approximately 5% of normal volume. On September 10, 1965, during the course of this strike, an accidental fire largely destroyed Central Tablet's equipment, machinery and building, none of which was subsequently repaired or replaced. The strike was never settled and Central Tablet never again engaged in manufacturing.

As of September 10, 1965, the plaintiff carried fire and extended coverage insurance on its buildings, machinery and inventory. It also carried business interruption insurance. The stated dollar limit of liability on the building was $225,000 under three separate policies of $75,000, which were identical except for the insurer. The stated dollar limit of liability on the machinery and inventory was $450,000 under one policy, The stated dollar limit of liability for business interruption was $100,000 under two policies identical except for the insurer.

Negotiation of Central Tablet's claim for business interruption loss began on approximately October 8, 1965. Disputes arose between Central Tablet and its insurers as to the estimated period of loss to be covered by business interruption insurance and as to the probable duration of the strike had there not been a fire, for the purpose of determining the "actual loss sustained" by Central Tablet during the period of loss covered under the insurance policies. No settlement on this claim was negotiated until August 25, 1967, and on or about September 22, 1967, Central Tablet received $67,000 in payment of its loss.

Negotiations of Central Tablet's insurance claims for building, machinery and personal property losses began on approximately November 1, 1965. Dispute arose regarding the applicability of a co-insurance clause contained in the building insurance policy, the extent of building loss, the value of the building at the time of the loss, the value of the machinery and equipment that was lost or damaged and the cost of repair of repairable machinery and equipment. Central Tablet accepted a settlement of its building insurance claim on approximately May 20, 1966, and on June 15, 1966, received $174,595.05 in payment thereof. On approximately August 25, 1966, Central Tablet accepted a settlement of its personal property claim and on or about November 17, 1966, received $104,609.27 in payment thereof.

On May 14, 1966, before the corporation had settled any of its claims or received any insurance funds, the shareholders of Central Tablet held a special meeting pursuant to notice, elected to dissolve the corporation and adopted a plan of dissolution and complete liquidation. A certified copy of the Resolution of Stockholders and Plan of Dissolution (see Exhibit 4) was filed with the Cincinnati District Director of Internal Revenue on May 25, 1966. On May 3, 1967, all remaining assets, after liquidating distributions to shareholders, were conveyed to the Ohio National Bank of Columbus, Ohio, in trust for the shareholders pending the complete winding-up of the corporation's affairs, including the payment of taxes and the collection of its insurance and other claims.

I THE APPLICABILITY OF SECTION 337

The primary question presented for decision is whether the plaintiff's gain from the involuntary conversion of its building, machinery and inventory is exempt from taxation by reason of Section 337(a) of the 1954 Internal Revenue Code, 26 U.S.C. § 337 (a).¹ The District Director, electing not to follow the decision of the Eighth Circuit Court of Appeals in United States v. Morton, 387 F.2d 441 (1968), concluded that such gain was taxable and assessed deficiencies against plaintiff in the amount of $70,051.30 for its tax year ending on October 31, 1965, and $11,930.30 for its 1963 tax year.² We conclude that the assessments made by the Director were erroneous in part, and we therefore grant partial judgment for the plaintiff.

The primary object of Section 337 of the Internal Revenue Code was remedial. First, the section intended to eliminate double taxation on the same gain, resulting when a corporation decides to liquidate and thereafter distributes its assets to shareholders themselves subject to taxation. See, United States v. Morton, supra; Pridemark, Inc. v. C. I. R., 345 F.2d 35 (4th Cir. 1965); West Street-Erie Boulevard Corp. v. United States, 411 F.2d 738 (2d Cir. 1969). Second, the section was promulgated to resolve the conflict created by disparate holdings in Commissioner of Internal Revenue v. Court Holding Co., 324 U.S. 331, 65 S.Ct. 707, 89 L.Ed. 981 (1944) and United States v. Cumberland Public Service Co., 338 U.S. 451, 70 S.Ct. 280, 94 L.Ed. 251 (1950), and to eliminate technical distinctions based upon the form of corporate dissolution created by these cases. See, United States v. Morton, supra, 387 F.2d at 444. The thrust of Section 337 is thus to create a rule of exemption which is understandable and easy to apply.

Difficulties of application have arisen, however, as a result of the Court of Claims' holding in Towanda Textiles v. United States, 180 F.Supp. 373, 149 Ct. Cl. 123 (1960), a case which established the principle that an involuntary conversion of corporate assets by accidental fire constitutes a "sale or exchange" of property, within the meaning and purpose of Section 337(a). The question which has been raised is this: At what point of time, for tax purposes, should such sale or exchange be deemed to take place? At the time of the involuntary conversion itself? At the time the taxpayer receives proceeds from the conversion? Or at the time that the right to receive proceeds becomes fixed and determinable? The Court in Towanda Textiles was not faced with this precise question, since in that case both the fire itself and the realization of proceeds from fire insurance occurred after a plan of liquidation had been adopted and within the 12-month period contemplated by the statute.

The precise question was raised and adjudicated in Morton v. United States, 258 F.Supp. 922 (W.D.Missouri 1966), the Missouri court holding:

"In order to carry out the clear intent of Congress in enacting § 337, that an involuntary conversion followed by adoption of a plan of complete liquidation by a corporation and the completion thereof within 12 months of its adoption, likewise comes within the intent of Congress when it exempted the corporation from liability for a tax on the gain derived from a sale on its property in liquidation."

In a lengthy and well-reasoned opinion, this holding was sustained by a unanimous Court in United States v. Morton, 387 F.2d 441 (8th Cir. 1968). The Court rejected as unpersuasive the Government's argument that conversion by fire is similar for tax purposes to a conversion by condemnation, where, depending on State law, the simple filing of a condemnation proceeding may give rise to a taxable gain to the condemnee. See, e. g., Covered Wagon, Inc. v. Commissioner of Internal Revenue, 369 F.2d 629 (8th Cir. 1966); Wendell v. Commissioner of Internal Revenue, 326 F.2d 600 (2d Cir. 1964). Unlike condemnation, the Court concluded, where a conclusive, constitutional right to compensation is vested in the condemnee on the date of the taking, a fire:

"is but the commencement of an involuntary conversion that does not come into fruition until, at least, the amount to be received by way of reimbursement for that loss is decided either by agreement or by court action ...

"The mere conversion of a tangible capital asset into a chose in action against an insurance company for an undetermined amount is not a completed `sale or exchange.' Collection is predicated upon compliance with policy conditions, which uniformly require a proof of loss and the allowance of a period of time within which the insurance company may make its investigation before suit may be properly instituted. It would thus appear that the `sale or exchange' by involuntary conversion is not completed until either the policy proceeds are received, or an enforceable settlement of a determined amount is agreed upon or a court judgment obtained. There certainly can be no gain to recognize until the amount of the proceeds is determined and made available.... Therefore, any gain resulting from the collection of the insurance proceeds would be entitled to nonrecognition under § 337." 387 F.2d at 447, 448.

The Court concludes that the reasoning and conclusions of Morton are persuasive. We adhere to its holding.

The Government asserts, however, that Morton is distinguishable from the present case, inasmuch as the claimant there was a cash basis taxpayer whereas the plaintiff here utilizes an accrual method of accounting. In addition, the Government has attempted to show, by way of deposition, that the fact of liability was never put in issue by taxpayer's insurance adjusters, although the amount of liability was subject to negotiation. Thus, the argument goes, this taxpayer's right to...