Commercial Industries Corp. v. United States

• Decision Date: 14 April 1967
• Docket Number: Civ. A. No. 565-64.
• Citation: 268 F. Supp. 52
• Parties: COMMERCIAL INDUSTRIES CORP., Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of New Jersey

268 F. Supp. 52

COMMERCIAL INDUSTRIES CORP., Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 565-64.

United States District Court D. New Jersey.

April 14, 1967.

Gutkin & Miller, by Sydney A. Gutkin, Newark, N. J., for plaintiff.

Mitchell Rogovin, Asst. Atty. Gen., Dept. of Justice, by John G. Milano, Atty., Dept. of Justice, for the United States.

OPINION

COOLAHAN, District Judge:

This is a civil action for refund of income taxes and interest assessed against and paid by the plaintiff, Commercial Industries Corp., Commercial, for the calendar years of 1956, 1957 and 1958, in the amounts set out in the margin.¹ Jurisdiction is premised on 28 U.S.C. §§ 1340, 1346.

The ultimate issue presented is whether the Commissioner of Internal Revenue properly disallowed the net operating loss carry-overs claimed as deductions by the plaintiff in its returns for those years, where such attempted carry-overs represent the net operating losses of a predecessor company, Seyer Silk Dyeing & Finishing Company, during the years 1951 through 1954.

The Government brings this motion for summary judgment. For the reasons given below the motion will be denied.

Since the chronology of events has been stressed by both sides in regard the applicable Tax Code provisions, a brief history of the matter will be useful. For purposes of this motion the Government is willing to assume the following facts.

Seyer Silk Dyeing & Finishing Co. Seyer was organized in 1931, and was engaged in the business of dyeing and finishing fabrics at its plant in Haledon, New Jersey.

On October 6, 1953, all the stock of Seyer was sold by the Seyer family to four individuals — Oliver Lazare, Bruno Herman, Samuel Fire, and Arthur Rhodes—for $320,513.65. The last three named individuals were at that time associated in the ownership and operation of Nina Dye Works Company, Inc. Nina, which was engaged in the same business of dyeing and finishing fabrics at its plant in York, Pennsylvania. Oliver Lazare, a customer of Nina, was invited to join in the purchase of Seyer by the owners of Nina.

Shortly after the purchase of the Seyer stock, the new owners voted to discontinue their own dyeing and finishing, allegedly on the ground that the machinery and equipment of Seyer was in poor condition and not capable of profitable operation. The machinery was sold,² but contact with Seyer's customers was retained; their orders for fabric were then obtained; and the actual dyeing and finishing was farmed out to other companies on a commission basis.

On May 24, 1954, seven months after the Seyer Company had been purchased, the other three owners bought Lazare's share of the Seyer stock for $140,949.88, representing a $34,000.00 gain to Lazare over his share of the original purchase price.

Thereafter, Seyer continued to accept orders on a commission basis for dyeing and finishing by other companies, until September, 1955.

Seyer incurred net operating losses during the years 1951 through 1954 which are set out in the margin.³ In 1955 the three remaining owners of Seyer decided to merge it with Nina, whose shares they owned in the same proportion as the shares of Seyer. Nina had continued to do its own dyeing and finishing up to the merger when its machinery and equipment were sold prior to the consummation. The mechanics of the merger were simply that Seyer acquired the assets and liabilities of Nina and changed its name, effective as of September 8, 1955, to Commercial Industries Corp. From that date on, the Government contends, the income of the new corporation was derived principally from rents, interests, dividends, and commissions. There was also a side transaction involving a third corporation which is not pertinent to this motion.⁴

The net operating losses listed above for Seyer were claimed by Commercial as deductions in the years 1955 through 1958 as noted.⁵ These deductions were claimed under Section 172 of Internal Revenue Code of 1954.⁶

These deductions were disallowed by the Commissioner who assessed deficiencies for those years. The deficiencies were paid, timely claim for refund filed, and the present action commenced.

II.

The Government argues that the attempted carryover is governed by the Internal Revenue Code I.R.C. of 1939 and the case law thereunder, which it claims prohibits the deductions. It maintains that such carryovers are precluded by Libson Shops, Inc. v. Koehler, 353 U.S. 382, 77 S.Ct. 990, 1 L.Ed.2d 924 (1957), and later cases applying that decision. Discussed more fully below, the Libson line of cases teaches that net operating losses cannot be carried forward (or back) to other tax years under Section 122 of the 1939 Code (predecessor of § 172, I.R.C.1954, supra) if there is an intervening substantial discontinuity between the business enterprise sustaining the losses and the enterprise which claims the deduction.

Plaintiff's reply is twofold. It feels that the availability of the carryover is governed not by the 1939 Code, but by the 1954 Code, under which it alleges that the carryover deductions were permissible. Alternatively, should the 1939 Code be deemed controlling, the plaintiff argues that the reasoning in Libson and its progeny are inapposite.

I find that plaintiff is incorrect as to the applicable Code, but I concur with its alternative argument that even under the 1939 Code the Government is not entitled to summary judgment.

Analysis of both issues has been somewhat obscured by several diversionary disputes. First, while it would seem obvious, it is necessary to emphasize that this is the defendant's motion; as movant, the Government is free to rely upon, or eschew, whichever grounds and theories it chooses. There were three points in the life of the Seyer Corporation which the Government claims resulted in substantial discontinuity of the business enterprise: (1) the 1953 100% change of stock ownership; (2) Seyer's shift to farming out dyeing and finishing on a commission basis; and (3) the 1955 statutory merger of Nina into Seyer with a concomitant change of the latter's name to Commercial Industries. Nonetheless, the Government made it absolutely clear that for purposes of this motion it relies solely upon the complete change of beneficial ownership in 1953 as precluding the carryover.⁷ Plaintiff's emphasis on the occurrence of the statutory merger in a 1954 Code year is understandable, since the many cases relied on by the Government involved mergers, acquisitions, or comparable reorganizations. Still, the defendant need not rely on the effect of the merger for purposes of this motion if it chooses not to. Hence my analysis of both the applicable Code and of the ultimate issue on the deduction is confined to the precise ground which is advanced, and, therefore, much of plaintiff's reference to the merger in regard to the applicability of the 1954 Code is not relevant.⁸

Second, plaintiff stresses the legitimate business purpose of the original stock purchase and urges that the Code provisions dealing with acquisition of corporate control made to avoid Federal income tax do not apply. § 129 (I.R.C. 1939); § 269 (I.R.C.1954). This too is an assault on open doorways, since the Commissioner did not rely on that provision in denying the deduction.⁹

III.

Turning to the question of which Code governs, I repeat that the merger of Nina into Seyer is not relied on for this motion. Despite plaintiff's admirable persistence on this point, its claim that "the operative transaction is * * * the statutory merger which occurred on September 8, 1955", is simply incorrect.

Plaintiff's second point is merely a justification for "applying subsequently enacted laws to determine the tax consequences of a pre-enactment transaction. * * *" However, plaintiff focuses on only two dates for testing the availability of a carryover, namely, the loss year and the tax year. The cases demonstrate that a tripartite analysis is necessary. The three relevant dates are: (1) the loss year; (2) the year in which the deduction is claimed or tax year; and (3) the year in which a discontinuity allegedly occurred in the corporate chain between the loss and the deduction. Of course under particular facts, the "discontinuity year" may be identical with either the "loss year" or the "tax year". But it is the "discontinuity year" which is critical, since it is the tax significance which the corporate combinations or transaction then had that determines whether the Libson gloss on Section 122 controls or whether the carryover is governed by the provisions of the 1954 Code which partially repeal Libson.¹⁰

Here not only the pertinent losses occurred in 1939 Code years,¹¹ but the event which purportedly cut off the carryover privilege occurred in 1953; its tax treatment and significance are determined under the 1939 Code. Allied Central Stores, supra; Fawick Corp. v. Commissioner, 342 F.2d 823 (6th Cir., 1955); Humacid Co., 42 T.C. 894 (1964); Norden-Ketay v. Commissioner, 319 F.2d 902 (2nd Cir., 1964) cert. denied, 375 U.S. 953, 84 S.Ct. 444, 11 L.Ed.2d 313. Cf. Fredrick Steele Co. v. Commissioner, 375 F.2d 351 (6th Cir., 1967) 67 — 1 U.S. T.C. 9279.¹²

Plaintiff's third point is based on Subsection 172(e) of the 1954 Code. It cites American Bank and Trust Co. v. United States, 333 F.2d 416 (5th Cir., 1964) for the proposition that § 172(e) requires the availability of loss carryovers for deduction in 1954 Code tax years to be determined under Section 172 of that Code. The reliance on Subsection (e) and on the American Bank case is misplaced.¹³ The pertinent subsection of § 172 in regard to the "availability" of pre-1954 Code year losses for deduction in 1954 Code years is § 172(g) (1) which indicates that their deductibility is governed by the 1939 Code. See Norden-Ketay, supra, 319 F.2d at 904.

The possible effect of the change in stock ownership in 1953, then, must be considered in the context of the restrictions placed on § 122...