ISC INDUSTRIES INC. v. Commissioner, Docket No. 4060-69.
| Decision Date | 03 November 1971 |
| Docket Number | Docket No. 4060-69. |
| Citation | 1971 TC Memo 283,30 TCM (CCH) 1216 |
| Parties | ISC Industries Inc., Successor of Indian Finance Corporation v. Commissioner. |
| Court | U.S. Tax Court |
Harry P. Dees, Union Federal Bldg., Evansville, Ind., for the petitioner. James J. McGrath, for the respondent.
Memorandum Findings of Fact and Opinion
The Commissioner determined the following deficiencies in petitioner's income tax:
Year Deficiency
1964 ........... $ 65,800.74
1965 ........... 80,412.05
___________
Total ........ $146,212.79
Nearly all of these amounts are in controversy as a result of respondent's determination that the principal purpose of petitioner's transfer of property subject to $375,000 of liabilities to its wholly-owned subsidiary in 1964 was tax avoidance on the exchange. Accordingly, respondent has invoked section 357(b)1 of the Internal Revenue Code of 1954 to hold that petitioner's gain on the exchange is taxable to the extent of the indebtedness assumed.
The original petitioner in this case is the Indian Finance Corporation, organized under the laws of the State of Indiana and having its principal office and place of business at all relevant times in Evansville, Ind. It filed its corporate Federal income tax returns with the district director of internal revenue, Indianapolis, Ind. Petitioner and Indian will hereafter be used to refer to original petitioner, Indian Finance Corporation.
On January 5, 1970, a merger plan between Indian and the named petitioner, ISC Industries, Inc., became effective. ISC Industries, Inc., was the surviving corporation, organized under the laws of the State of Delaware and having its principal place of business in Kansas City, Mo. ISC Industries, Inc., is liable at law for any deficiencies determined against Indian in the instant proceedings.
During the years at issue Indian was in the consumer finance business. It engaged in the retail or time sales financing of automobiles, furniture, and appliances, and it also made direct loans to consumers pursuant to a small loan license granted by the State of Indiana. Indian also sold credit life insurance and health and accident insurance to its loan customers in addition to engaging in a general insurance business. Indian was among the top 150 companies out of about 7,500 companies in similar lines of business with assets of about $15,000,000 in 1964.
In June 1964, Indian's president, Joseph E. O'Daniel, became aware of an opportunity to buy a majority interest in Lincoln Bakery, Inc. (hereafter referred to as Lincoln), a large bakery located in Evansville, Ind. On June 29, 1964, O'Daniel circulated a memorandum among the directors of Indian recommending that the stock of Lincoln be purchased and that thereafter Lincoln be merged into Indian. The basis for O'Daniel's recommendation was that Lincoln had always been profitable and that Indian needed additional profits to obtain more favorable borrowing rates from the institutions which supplied it with funds for its finance business.
At a special meeting held on June 30, 1964, the directors of Indian approved the purchase of 52.846 percent of the outstanding stock of Lincoln for $1,060,000. The price was to be paid with funds that Indian had borrowed for use in its finance business. In addition to the advantages flowing from the anticipated profits of Lincoln the directors felt that Indian would obtain other benefits from the proposed merger. Among these would be the acquisition of roughly 1,400 new shareholders who previously owned the minority interest in Lincoln and some insurance against the decline in profitability in the finance business by diversification.
On or about July 1, 1964, the shares of Lincoln were acquired by Indian, and on October 2, 1964, the merger of Lincoln into Indian was finally consummated. At the time of the purchase of the stock the directors of Indian had not decided whether to operate the bakery after the merger as an unincorporated division or as a wholly-owned subsidiary corporation.
During the time that Indian was in the process of purchasing the Lincoln stock, its directors knew that the proposed acquisition was in violation of agreements that it had with various institutions which were the principal suppliers of funds for its finance business. Because of their conviction that the investment in the bakery was sound, the directors did not anticipate that these financial institutions would oppose the acquisition; however, it developed that upon learning of Indian's investment in the bakery the lending institutions were more than a little concerned. In particular, The Omaha National Bank immediately withdrew its line of credit to Indian's finance business, and several other institutions threatened to withdraw their credit unless Indian took certain steps. In the main, these lenders were concerned that Indian was unfamiliar with the bakery business and that it had diverted over one million dollars that they had lent Indian for the finance business from their intended use.
In order to insure continued credit from the financial institutions which supplied it with funds for its finance business, Indian determined that it was necessary to insulate Indian's finance business from any losses or obligations that might be incurred in the bakery's operation and to return for use in the finance business the money that it had used to purchase the Lincoln stock. With the approval of the lending institutions, Indian decided to operate the bakery as a wholly-owned subsidiary corporation after Lincoln's merger into Indian. Indian's plan entailed the transfer of only the operating assets of the bakery to the subsidiary while retaining most of Lincoln's cash and liquid assets and also placing a $375,000 mortgage on the bakery assets which the subsidiary would assume. These latter two steps would reduce Indian's investment in the bakery from over a million dollars to under three hundred thousand.
On October 2, 1964, the same day that the merger of Lincoln into Indian became finally consummated, Indian borrowed $375,000 using the bakery assets as security and then transferred the bakery assets subject to this liability to its wholly-owned subsidiary, the "new" Lincoln Bakery, Inc. (hereafter new Lincoln), in exchange for new Lincoln stock. Indian retained the mortgage proceeds for use in its finance business.
The gain realized by petitioner on the transfer of assets to "new" Lincoln was $372,572.20.
1. Indian's principal purpose in causing "new" Lincoln to assume the $375,000 of liabilities was to protect its lines of credit for its finance business and was not to avoid Federal income tax on the exchange.
2. Indian's purpose of protecting its lines of credit for its finance business was a bona fide business purpose.
OpinionRespondent claims that this case is the classic situation for the application of section 357(b). Petitioner purchased a majority stock interest in Lincoln Bakery, Inc., with the intention that Lincoln be merged into it. On the same day that the merger became finally consummated, petitioner mortgaged the bakery assets for $375,000 and then transferred them to a new subsidiary subject to the obligation in exchange for the stock of the subsidiary. Petitioner retained the mortgage proceeds for use in its finance business. Respondent determined that under these circumstances the assumption of the mortgage by the subsidiary should be treated as money or other property received in a transfer to which section 351 otherwise applied. Accordingly, respondent found that the gain of $372,572.20 realized on the exchange should be fully recognized because the liabilities assumed exceeded this amount. We disagree with respondent.
The legislative and judicial histories with respect to the assumption of liabilities in transactions in which a taxpayer exchanges encumbered property for stock or securities of his controlled corporation are well recounted elsewhere. See Drybrough v. Commissioner 67-1 USTC ¶ 9340, 376 F. 2d 350, at 355-56 (C. A. 6, 1967);2 W. H. B. Simpson Dec. 27,306, 43 T. C. 900, at 915-16 (1965); and H. Rept. No. 855, 76th Cong., 1st Sess., pp. 5 and 18-20 (1939). With two exceptions, section 3573 permits a taxpayer to transfer encumbered property to his controlled corporation in exchange for stock or securities in the corporation without recognition of gain. The exception provided in section 357(c) applies only when the liabilities assumed by the transferee corporation exceed the transferor's basis for the property exchanged and is not here relevant.
This case deals with the exception provided in section 357(b). Section 357(b) applies in two cases: (1) where under the applicable circumstances it appears that the principal purpose of the transferor in causing the assumption of the liability was to avoid Federal income tax on the exchange; and (2) where in the absence of a tax avoidance purpose the assumption was not effected for a bona fide business purpose. In these two cases the total amount of all liabilities assumed will be treated as "boot" in determining the amount of gain recognized under section 351(b) and other statutes.
Because section 357(b) by its terms deals only with the purpose of a transferor in causing an assumption of liabilities, the cases dealing with this provision have been more concerned...
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