CENTRAL TABLET MFG. CO. V. UNITED STATES

CourtUnited States Supreme Court
Writing for the CourtJustia & Oyez
Citation417 U. S. 673
Decision Date19 June 1974

Central Tablet Mfg. Co. v. United States

No. 73-593

Argued March 25-26, 1974

Decided June 19, 1974

417 U.S. 673


CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

Syllabus

When a fire destroys insured corporate property prior to the corporation's adoption of a complete plan of liquidation but the fire insurance proceeds are received within 12 months after the plan's adoption, the gain realized from the excess of such proceeds over the corporate taxpayer's adjusted income tax basis in the insured property must be recognized and taxed to the corporation, and is not entitled to nonrecognition under § 337(a) of the Internal Revenue Code of 1954, which provides, with certain exceptions, for nonrecognition of gain or loss from a corporation's "sale or exchange" of property that takes place during the 12-month period following the corporation's adoption of a plan for complete liquidation effectuated within that period. P P. 677-691.

(a) The involuntary conversion by fire, recognized as a "sale or exchange" under § 337(a), takes place when the fire occurs prior to the adoption of the liquidation plan, and not at some post-plan point, such as the subsequent settlement of the insurance claims or their payment, since the fire is the single irrevocable event that fixes the contractual obligation precipitating the transformation of the property, over which the corporation possesses all incidents of ownership, into a chose in action against the insurer. P P. 683-685.

(b) Section 337(a) was enacted in order to eliminate technical and formalistic determinations as to the identity of the vendor, as between the liquidating corporation and its shareholders, and, therefore, the reasons for applying § 337(a) are not present in a situation where the conversion takes place prior to the adoption of the plan when there is no question as to the identity of the owner. P P. 686-687.

481 F.2d 954, affirmed.

BLACKMUN, J., delivered the opinion of the Court, in which BURGER, C.J., and STEWART, MARSHALL, and REHNQUIST, JJ., joined. WHITE, J., filed a dissenting opinion, in which DOUGLAS, BRENNAN, and POWELL, JJ., joined, post, P. 691.

Page 417 U. S. 674

MR. JUSTICE BLACKMUN delivered the opinion of the Court.

Section 337(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 337(a), [Footnote 1] provides, with stated exceptions, for the nonrecognition of gain or loss from a corporation's "sale or exchange" of property that takes place during the 12-month period following the corporation's adoption of a plan of complete liquidation that is effectuated within that period. The issue in this case is whether, when a fire destroys corporate property prior to the adoption of a plan of complete liquidation, but the fire insurance proceeds are received after the plan's adoption, the gain realized is or is not to be recognized to the corporation.

I

The facts are not contested. Taxpayer, Central Tablet Manufacturing Company, an Ohio corporation, for

Page 417 U. S. 675

many years prior to May 14, 1966, was engaged at Columbus, Ohio, in the manufacture and sale of writing tablets, school supplies, art materials, and related items. It filed its federal income tax returns on the accrual basis of accounting and for the fiscal year ended October 31.

On August 13, 1965, a majority of the taxpayer's production and maintenance employees went on strike. As a consequence, production was reduced to about 5% of normal volume. On September 10, during the strike, an accidental fire largely destroyed the taxpayer's plant, its manufacturing equipment and machinery, and its business offices. The damage was never repaired, the strike was never settled, and the taxpayer never again engaged in manufacturing.

At the time of the fire, the taxpayer carried fire and extended coverage insurance on its building, machinery, and inventory. It also carried business interruption insurance. Negotiations relating to the taxpayer's claim for business interruption loss began about October 8, 1965, and those on its claims for building and personal property losses began about November 1. There was dispute as to the estimated period of loss to be covered by the business interruption insurance; as to the probable duration of the strike had the fire not taken place; as to the applicability of the building policy's coinsurance clause; as to the extent of the equipment loss due to the fire, rather than to rain; as to the value of the building and equipment at the time of the fire; and as to the cost of repair of repairable machinery and equipment. The threshold liability of the insurance carriers, however, despite their not unusual rejection of the initial formal proofs of claim, was never seriously questioned.

Eight months after the fire, at a special meeting on May 14, 1966 the shareholders of Central Tablet decided to dissolve the corporation and adopted a plan of dissolution

Page 417 U. S. 676

and complete liquidation pursuant to Ohio Rev.Code Ann. § 1701.86 (1964). App. 38. About six days later, the taxpayer and the insurers settled the building claim; payment of that claim was received in mid-June. In August, the taxpayer settled its personal property claim and received payment on it in November. On May 3, 1967, all assets remaining after liquidating distributions to the shareholders were conveyed to a Columbus bank in trust for the shareholders pending the payment of taxes and the collection of remaining insurance and other claims. On the same date, the taxpayer filed a certificate of dissolution with the Ohio Secretary of State. Ohio Rev.Code Ann. §§ 1701.86(H) and (I) (1964). All this was accomplished within 12 months of the adoption of the plan on May 14, 1966.

The business interruption claim was settled in August, 1967, and payment thereof was received in September of that year.

The fire insurance proceeds exceeded the taxpayer's adjusted income tax basis in the insured property. Gain, therefore, was realized, and ordinarily would be recognized and taxed to the corporation. § 1033(a)(3) of the 1954 Code, 26 U.S.C. § 1033(a)(3); Tobias v. Commissioner, 40 T.C. 84, 95 (1963). The taxpayer, however, resorting to § 337(a), did not report this gain or any part of the business interruption insurance payment in its income tax returns for fiscal 1965 or for any other year. In January, 1968, upon audit, the Internal Revenue Service asserted a deficiency in the taxpayer's income tax for fiscal 1965. This was attributable to the Service's inclusion in gross income for that year of (a) capital gain equal to the excess of the fire insurance proceeds over adjusted basis, (b) fiscal 1965's pro rata hare of the business interruption insurance payment, and (c) an amount not at issue here. A deficiency in the taxpayer's fiscal

Page 417 U. S. 677

1963 tax was also asserted; this was attributable to a decrease in operating loss carryback from fiscal 1966 because of adjustments in the treatment of the insurance proceeds. [Footnote 2] The taxpayer paid the deficiencies, filed claims for refund, and, in due time, instituted the present action in federal court to recover the amounts so paid.

The District Court followed the decision in United States v. Morton, 387 F.2d 441 (CA8 1968), which concerned a taxpayer on the cash, rather than the accrual, basis, and held that § 337(a) was available to the taxpayer. 339 F.Supp. 1134 (SD Ohio 1972). [Footnote 3] Judgment for the taxpayer was entered. On appeal, the United States Court of Appeals for the Sixth Circuit, refusing to follow Morton, reversed and remanded. 481 F.2d 954 (1973). In view of the indicated conflict in the decisions of the Eighth and Sixth Circuits, we granted certiorari. 414 U.S. 1111 (1973).

II

The only issue before us is whether § 337(a) has application in a situation where, as here, the involuntary conversion occasioned by the fire preceded the adoption of the plan of complete liquidation. [Footnote 4] This depends upon whether the "sale or exchange," referred to in § 337(a),

Page 417 U. S. 678

took place when the fire occurred or only at some post-plan point, such as the subsequent settlement of the insurance claims, or their payment.

Stated simply, it is the position of the Government that the fire was a single destructive event that effected the conversion (and, therefore, the "sale or exchange") prior to the adoption of the plan of liquidation, thereby rendering § 337(a) inapplicable. It is the position of the taxpayer, on the other hand, that the fire was not such a single destructive event at all, but was only the initial incident in a series of events -- the fire; the preparation and filing of proofs of claim; their preliminary rejection; the negotiations; ultimate dollar agreement by way of settlement; the preparation and submission of final proofs of claim; their formal acceptance; and payment -- that stretched over a period of time and came to a meaningful conclusion only after the adoption of the plan, and that, consequently, § 337(a) is applicable.

In order to keep this narrow issue in perspective, it is desirable and necessary to examine the background and the history of § 337.

A corporation is a taxable entity separate and distinct from its shareholders. Ordinarily, a capital gain realized by the corporation is taxable to it. The shareholders, of course, benefit by that realization of gain and the consequent increase in their corporation's assets. The value of their shares, in theory, is thereby enhanced. This increment in value, however, is not taxed at that point to the shareholder. His taxable transaction occurs when he disposes of his shares. The capital gain realized by the corporation, and taxed to it, may be said to be subject to a "second" tax later, that is, when the shareholder disposes of his shares. There is nothing unusual about this. It is a reality of tax law, and it is due to the separateness of the corporation and the shareholder as taxable entities.

Page 417 U. S. 679

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1 practice notes
  • FRANK LYON CO. V. UNITED STATES
    • United States
    • United States Supreme Court
    • April 18, 1978
    ...Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U. S. 134, 148-149 (1974); Central Tablet Mfg. Co. v. United States, 417 U. S. 673, 690 There is no simple device available to peel away the form of this transaction and to reveal its substance. The effects of the transaction o......
1 cases
  • FRANK LYON CO. V. UNITED STATES
    • United States
    • United States Supreme Court
    • April 18, 1978
    ...Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U. S. 134, 148-149 (1974); Central Tablet Mfg. Co. v. United States, 417 U. S. 673, 690 There is no simple device available to peel away the form of this transaction and to reveal its substance. The effects of the transaction o......

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