Heverly v. C. I. R.

Decision Date25 March 1980
Docket NumberNo. 4953-74,No. 6187-74,4953-74,6153-74,No. 8602-74,No. 6153-74,79-2192,No. 79-1985,6187-74 and 8602-74,4953-74,6153-74,6187-74,8602-74,79-1985
Citation621 F.2d 1227
Parties80-1 USTC P 9322 Arden S. HEVERLY and Sophia S. Heverly v. COMMISSIONER OF INTERNAL REVENUE. (Tax Court) Edna L. BOYER, Deceased, by John H. Bozic, Jr., Executor of the Estate of Edna L. Boyer v. COMMISSIONER OF INTERNAL REVENUE. (Tax Court) Katherine D. HARVEY v. COMMISSIONER OF INTERNAL REVENUE. (Tax Court) John J. DeFRAINE and Agnes C. DeFraine v. COMMISSIONER OF INTERNAL REVENUE. (Tax Court) Appeal of COMMISSIONER OF INTERNAL REVENUE. John Lewis PIERSON v. UNITED STATES of America, Appellant.
CourtU.S. Court of Appeals — Third Circuit

Ernest J. Brown (argued), M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, Tax Div., Dept. of Justice, Washington, D. C., for appellants; James W. Garvin, Jr., U. S. Atty., Wilmington, Del., of counsel.

John H. Schafer (argued), Newman T. Halvorson, Jr., Charles Lister, Covington & Burling, Washington, D. C., Stephen D. Gardner (argued), James S. Eustice, Kronish, Lieb, Shainswit, Weiner & Hellman, New York City, for appellees; Robert A. Kagan, Edwin A. Kilburn, New York City, of counsel.

Before ALDISERT, WEIS and HIGGINBOTHAM, Circuit Judges.


ALDISERT, Circuit Judge.

The major issue presented by these consolidated appeals from the United States Tax Court and the United States District Court for the District of Delaware is whether the use of consideration other than voting stock is allowable in a tax deferred stock for stock reorganization as defined in § 368(a)(1)(B) of the Internal Revenue Code, 26 U.S.C. § 368(a)(1)(B). In the vernacular, the question is whether "boot" may be used in a clause B corporate reorganization. Both courts below agreed with the taxpayers that other consideration is allowable so long as "control" of the target corporation is obtained "solely for . . . voting stock," and thus allowed them to defer recognition of their gain under § 354(a)(1), 26 U.S.C. § 354(a)(1). We hold that, in a stock for stock transaction in which control is achieved, the acquiring corporation may exchange no consideration other than voting stock to effect a tax deferred clause B reorganization. We therefore reverse.


The facts have been detailed in the trial court opinions, Reeves v. Commissioner, 71 T.C. 727, 728-31 (1979), and Pierson v. United States, 472 F.Supp. 957, 958-60 (D.Del.1979), so we need not elaborate them at length. The transaction at issue involved the acquisition of stock in Hartford Insurance Company by International Telephone and Telegraph Corporation. ITT first made overtures to the management of Hartford in 1968, suggesting either an acquisition of Hartford by ITT or merger of Hartford into ITT. Hartford rejected these immediate proposals, but apparently gave no definitive veto to a future amalgamation. ITT subsequently purchased for cash, in two block transactions and various open market transactions, approximately eight percent of Hartford's outstanding stock.

In December 1968, ITT proposed merger terms to Hartford, leading to a provisional agreement on April 9, 1969, to merge Hartford into a wholly owned subsidiary of ITT. The Antitrust Division of the Department of Justice commenced litigation to enjoin the merger in August 1969, but its motion for preliminary injunction was denied in October 1969. On October 13, 1969, the Internal Revenue Service issued a private letter ruling advising ITT and Hartford that the proposed merger would be within § 368(a)(1)(B) if ITT unconditionally divested itself of the Hartford stock it had previously purchased for cash. On October 21, the IRS ruled that ITT's proposed sale of the stock to Mediobanca, an Italian bank, would constitute an unconditional disposition, and ITT consummated the sale.

Although ITT overcame the obstacles erected by the Antitrust Division and the IRS, and obtained approval for the transaction from the Hartford and ITT shareholders, the merger fell through when the Connecticut Insurance Commissioner withheld his approval. ITT and Hartford then proposed an offer to the Hartford shareholders of ITT stock for their Hartford stock. The Connecticut Insurance Commissioner ultimately approved this plan, and ITT submitted the exchange offer to the Hartford shareholders on May 26, 1970. By June 8, 1970, over ninety-five percent of the Hartford shares, including those held by Mediobanca, had been tendered.

In March 1974, the IRS, alleging misrepresentations in ITT's application for the private letter ruling regarding the sale of Hartford stock to Mediobanca, retroactively revoked its ruling that deemed that sale an unconditional disposition of the stock. The effect of the revocation, according to the IRS, was to disqualify the transaction from treatment under clause B and thus to preclude tax deferral of the gain realized by the Hartford shareholders when they exchanged their Hartford stock for ITT stock. The Service reasoned that clause B allows no consideration other than voting stock, and that the purchase for cash of eight percent of Hartford stock by ITT precluded treatment of the transaction under clause B. As a result, the Service assessed tax deficiencies against the former Hartford shareholders, including the appellees here. 1


In the trial courts, taxpayers sought deferral of their gain under § 354(a) of the Internal Revenue Code, 26 U.S.C. § 354(a), arguing that they participated in a corporate reorganization. They rely on § 368(a)(1)(B), which defines "reorganization" as an acquisition, solely for voting stock, of stock of another corporation, if the acquiring corporation is in "control" of the other corporation immediately after the exchange.

The two courts below granted taxpayers' motion for summary judgment, though on somewhat different grounds. Before both courts, taxpayers asserted alternative grounds for summary judgment. They argued initially that the cash purchases of stock by ITT in 1968 were not part of the same "plan of reorganization" as its acquisition of ninety-five percent of Hartford's stock in 1970. The requirement that the exchange be "solely for voting stock" was thus fulfilled because the prior cash purchases should not be considered. Their alternative argument was that even if the cash purchases were part of the plan of reorganization, they constituted a separate "transaction" from the exchange of stock for stock. Under their interpretation, clause B requires only the acquisition of "control" of the target corporation "solely for . . . voting stock" of the acquiring corporation. Thus, ITT's acquisition was within clause B because the stock transaction gave it "control" of Hartford. Both courts accepted the second argument and, concluding that it was fully dispositive, declined to address the first argument.


The appeal from the tax court emanates from a case styled Reeves v. Commissioner, 71 T.C. 727 (1979), which held that ITT's acquisition of more than eighty percent of Hartford's stock in a single transaction satisfied the "solely for voting stock" requirement of clause B, regardless of the cash exchanges. Id. at 741-42. In an opinion announcing the decision of the court, 2 Judge Tannenwald began his analysis with an observation that the legislative history underlying § 368 is inconclusive on this issue. Id. at 732 (citing Turnbow v. Commissioner, 368 U.S. 337, 344 n.8, 82 S.Ct. 353, 357 n.8, 7 L.Ed.2d 326 (1961). He distinguished Helvering v. Southwest Consolidated Corp., 315 U.S. 194, 62 S.Ct. 546, 86 L.Ed. 789 (1942), in which the Supreme Court held that an earlier version of the reorganization section dealing with both stock for stock and stock for asset exchanges allowed no consideration other than voting stock, because it involved an asset acquisition, not a stock acquisition. He also noted that Southwest Consolidated addressed a situation in which voting stock represented only sixty-three percent of the total consideration. 71 T.C. at 734-35.

Judge Tannenwald distinguished other decisions by grouping them into two categories. The first category included decisions in which the control requirement could be met only by taking into account prior acquisitions. In this category he grouped Lutkins v. United States, 312 F.2d 803, 160 Ct.Cl. 648, cert. denied, 375 U.S. 825, 84 S.Ct. 65, 11 L.Ed.2d 57 (1963), Commissioner v. Air Reduction Co., 130 F.2d 145 (2d Cir.), cert. denied, 317 U.S. 681, 63 S.Ct. 201, 87 L.Ed. 546 (1942), and Pulfer v. Commissioner, 43 B.T.A. 677 (1941), aff'd 128 F.2d 742 (6th Cir. 1942) (per curiam). 71 T.C. at 736. The second category of decisions involved single transactions in which more than eighty percent of the target corporation's stock was acquired but both voting stock and other consideration was used in the acquisition. 71 T.C. at 736. Included in this category were Turnbow v. Commissioner, 368 U.S. 337, 82 S.Ct. 353, 7 L.Ed.2d 326 (1961), Mills v. Commissioner, 39 T.C. 393 (1962), rev'd, 331 F.2d 321 (5th Cir. 1964), and Howard v. Commissioner, 24 T.C. 792 (1955), rev'd on other grounds, 238 F.2d 943 (7th Cir. 1956). More specifically, "(i)n Mills and Turnbow, each shareholder whose stock was being acquired got cash." 71 T.C. at 736. In addition, "Howard is factually distinguishable . . . because some stockholders involved in the one exchange transaction . . . received cash." Id. at 737. Judge Tannenwald concluded that neither category should apply to a situation in which ITT obtained "control" of Hartford by giving only ITT shares for Hartford shares in exchanges clearly separable from concurrent cash exchanges.

As support for his conclusion that clause B is undeserving of a "pervasively rigid interpretation," Judge Tannenwald noted that legislative amendments of clause B indicate a continuing congressional concern that courts were interpreting the "solely" requirement too rigidly and that the IRS...

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