COMMISSIONER OF INTERNAL REVENUE v. Phipps

• Decision Date: 10 March 1948
• Docket Number: No. 3542.,3542.
• Citation: 167 F.2d 117
• Parties: COMMISSIONER OF INTERNAL REVENUE v. PHIPPS.
• Court: U.S. Court of Appeals — Tenth Circuit

167 F.2d 117 (1948)

COMMISSIONER OF INTERNAL REVENUE v. PHIPPS.

No. 3542.

Circuit Court of Appeals, Tenth Circuit.

March 10, 1948.

Harry Marselli, of Washington, D. C., (Theron Lamar Caudle, Asst. Atty. Gen., Helen R. Carloss, Lee A. Jackson, and Helen Goodner, Sp. Assts. to Atty. Gen., on the brief), for petitioner.

W. Clayton Carpenter, of Denver, Colo., (Montgomery Dorsey, Wm. L. Branch and Hughes & Dorsey, all of Denver Colo., on the brief), for respondent.

Before PHILLIPS, BRATTON and HUXMAN, Circuit Judges.

BRATTON, Circuit Judge.

This proceeding is here on petition to review a decision of the Tax Court. Margaret R. Phipps, hereinafter referred to as the taxpayer, owned certain shares of preferred stock issued by Nevada-California Electric Corporation. On or about December 1, 1936, Nevada-California Electric Corporation, hereinafter referred to as the parent company, liquidated five wholly owned subsidiary corporations and took over their assets in complete cancellation and redemption of all of their outstanding capital stock. No gain or loss was recognized for income tax purposes on the liquidation. At the time of the liquidation, one of the subsidiaries had earnings or profits accumulated prior to March 1, 1913, in the total amount of $937,465.97, and earnings or profits accumulated after February 28, 1913, in the sum of $90,362.77. The other four subsidiaries were without accumulated earnings or profits and had deficits in the total amount of $3,147,803.62. As of December 31, 1936, the parent company had earnings or profits accumulated prior to March 1, 1913, in the amount of $18,060.94, and it had earnings or profits accumulated since February 28, 1913, in the amount of $2,129,957.81, all exclusive of the earnings or profits of the one subsidiary and of the deficits of the four. The earnings or profits of the parent company for the year 1937 amounted to $390,387.02, and the cash distributions to owners of preferred stock during the year totaled $802,284.00. Of the cash distributed, $390,387.02 was paid out of current earnings or profits, and the remaining $411,896.98 was not paid out of such earnings or profits. The taxpayer received distributions during the year 1937 in the amount of $18,480.00, of which $8,992.28 was paid out of current earnings or profits, and the remaining $9,487.72 was not paid out of such earnings or profits. She seasonably reported the entire amount for income tax purposes but later filed a claim for refund on the ground that the entire amount received and reported did not constitute taxable dividends. The Commissioner of Internal Revenue denied the claim. The Tax Court held that of the amount distributed to the taxpayer, only $8,992.28 constituted taxable dividends. The Commissioner sought review.

The question presented is whether in determining the amount of earnings or profits of the parent company available for distribution to stockholders after the liquidation of the subsidiaries, the surplus of one subsidiary should be included but the deficits of the other four excluded, or whether the earnings of the one and the deficits of the four should all be taken into account. Section 22(a) of the Revenue Act of 1936, 49 Stat. 1648, 26 U.S.C.A. Int.Rev. Acts, page 825, includes dividends in the definition of gross income. Section 115(a), 26 U.S.C.A. Int.Rev. Acts, page 868, defines a dividend for purposes of the income tax title as a distribution in money or in other property made by a corporation to its shareholders (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year, without regard to the amount of the earnings and profits at the time the distribution was made. And section 115(b) provides that for purposes of the Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. It is well settled that where one corporation acquires all of the assets of another corporation in a tax-free reorganization, the accumulated earnings or profits of the predecessor corporation are carried forward intact into the acquiring corporation as earnings or profits and are available for distribution as dividends to its stockholders, even though the acquiring corporation may have treated them as capital on its books. Commissioner v. Wheeler, 324 U.S. 542, 65 S.Ct. 799, 89 L.Ed. 1166; Commissioner v. Munter, 331 U.S. 210, 67 S.Ct. 1175; Commissioner v. Sansome, 2 Cir., 60 F.2d 931, certiorari denied, 287 U.S. 667, 53 S.Ct. 291, 77 L.Ed. 575; United States v. Kauffmann, 9 Cir., 62 F.2d 1045; Murchison's Estate v. Commissioner, 5 Cir., 76 F.2d 641; Harter v. Helvering, 2 Cir., 79 F.2d 12; Baker v. Commissioner, 2 Cir., 80 F.2d 813; Corrigan v. Commissioner, 3 Cir., 103 F.2d 1010, certiorari denied, 308 U.S. 576, 60 S. Ct. 91, 84 L.Ed. 482; Georday Enterprises v. Commissioner, 4 Cir., 126 F.2d 384; Reed Drug Co. v. Commissioner, 6 Cir., 130 F. 2d 288; Putnam v. United States, 1 Cir., 149 F.2d 721; Crossett Western Co. v. Commissioner, 3 Cir., 155 F.2d 433, certiorari denied, 329 U.S. 729, 67 S.Ct. 84.

But the Commissioner urges that the rule is limited to the treatment of accumulated earnings or profits of the company liquidated or absorbed, and that it does not include carrying forward the deficit in earnings or profits of the company liquidated or absorbed into the corresponding account of the emerged company in determining whether distributions subsequently made by the emerged company to its stockholders are made from earnings or profits or from capital. In a tax-free reorganization of corporations where a parent liquidates a wholly owned subsidiary, taking over its assets subject to their liabilities in complete cancellation and redemption of its issued and outstanding capital stock, or where two corporations merge, the entire corporate life survives as a continued venture insofar as tax consequences are concerned. A transaction of that kind does not produce any change in respect of tax purposes, the successor being merely the continuation of the predecessor. The principle is not a narrow one, limited to accumulated earnings or profits of the liquidated or absorbed company. It includes a deficit in the earnings or profits account of such company. The earnings and profits accounts of the transferor company, whether consisting of credit balances or deficits, should be reflected in the corresponding accounts of the transferee company and should be taken into account in determining whether distributions subsequently made to stockholders of the emerged company were paid out of earnings or profits or out of capital. Harter v. Helvering, supra. The case of Cranson v. United States, 9 Cir., 146 F.2d 871, certiorari denied, 326 U.S. 717, 66 S.Ct. 22, 90 L.Ed. 424, on which the Commissioner places strong reliance is not to the contrary. There the taxpayer contended that the earnings or profits of the parent company were reduced by operating deficits taken over in the liquidation of wholly owned subsidiaries, and that in consequence the distribution made to him as a stockholder in the parent company was out of capital, not earnings. But the court did not pass upon that question. Instead, it was held that in the absence of an affirmative showing that the deficits of the subsidiaries were incurred during the year in which the parent made the distribution to the taxpayer, the question was not before the court for consideration.

Conceding that prior to 1936, where a corporation had a deficit in its earned surplus account caused by operating losses, the deficit must have been restored by applying earnings subsequently received against the deficit before any of the subsequent earnings could be considered as accumulated earnings available for distribution as taxable dividend, the Commissioner urges that the rule was modified by section 115(a) of the Revenue Act of 1936, supra; and that under the provisions of that section, current earnings are available first for payment of dividends, and only the current rent earnings which are not distributed may be used to restore a deficit in the earned surplus account. But the only change effected by the statute was to make dividends paid out of earnings or profits of the taxable year subject to tax in the hands of the distributee without regard to the amount of accumulated earnings or profits for earlier years, and that change has no material bearing here.

The decision of the Tax Court is affirmed.

Judge HUXMAN, Circuit Judge (dissenting).

I cannot escape the conclusion that the decision of the Tax Court is wrong and should be reversed. The factual situation is set out in detail in the majority opinion and will be referred to only so far as is necessary for the purpose of this opinion. The Nevada-California Electric Corporation will be referred to as the Parent. Prior to December 1, 1936, it owned five wholly owned subsidiary corporations. One of these subsidiaries had accumulated earnings after February 28, 1913, of $90,362.77. The other four had accumulated deficits of $3,147,803.62.

These five subsidiaries were liquidated on or before December 1, 1936, in a tax-free proceeding by a surrender of all of the assets to the Parent. No gain or loss was or could be recognized as a result by virtue of Section 112(b) (6) of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev. Acts, page 856, and the Parent accordingly reported no gain or loss as a result thereof.

At the time these subsidiaries were taken over, the Parent had no deficit in its capital structure, but on the other hand had accumulated earnings and profits of...