King Enterprises, Inc. v. United States

• Decision Date: 14 November 1969
• Docket Number: No. 114-66.,114-66.
• Citation: 418 F.2d 511
• Parties: KING ENTERPRISES, INC. v. The UNITED STATES.
• Court: U.S. Claims Court

418 F.2d 511 (1969)

KING ENTERPRISES, INC. v. The UNITED STATES.

No. 114-66.

United States Court of Claims.

November 14, 1969.

Thomas A. Caldwell, Jr., Chattanooga, Tenn., attorney of record for plaintiff. Stophel, Caldwell & Heggie, Chattanooga, Tenn., of counsel.

Norman J. Hoffman, Jr., Washington, D. C., with whom was Asst. Atty. Gen. Johnnie M. Walters, for defendant. Philip R. Miller, Washington, D. C., and Joseph Kovner, Washington, D. C., of counsel.

Before COWEN, Chief Judge, and LARAMORE, DURFEE, DAVIS, COLLINS, SKELTON and NICHOLS, Judges.

OPINION

PER CURIAM:

This case was referred to Trial Commissioner C. Murray Bernhardt with directions to make findings of fact and recommendation for conclusions of law under the order of reference and Rule 57(a) since September 1, 1969 Rule 134(h). The commissioner has done so in an opinion and report filed on May 27, 1969. On June 25, 1969 defendant filed its notice of intention to except which defendant has subsequently withdrawn. On October 1, 1969 plaintiff filed a motion that the court adopt the commissioner's findings of fact, opinion and recommendation for conclusion of law as the basis for its judgment in this case. Since the court agrees with the commissioner's opinion, findings and recommended conclusion of law, as hereinafter set forth, it hereby adopts the same as the basis for its judgment in this case without oral argument. Therefore, plaintiff's motion of October 1, 1969 is granted and it is concluded that plaintiff is entitled to recover. Judgment is entered for plaintiff with the amount of recovery to be determined pursuant to Rule 131(c) prior to September 1, 1969 Rule 47(c).

OPINION OF COMMISSIONER

BERNHARDT, Commissioner:

This is an action to recover Federal income taxes paid by petitioner for the fiscal year ended June 30, 1960. The issues involve the proper characterization for tax purposes of the transaction in question, and the tax treatment of the resulting gain. The facts detailed in the accompanying report, condensed here, sustain the conclusion that the petitioner is entitled to recover.

Petitioner, King Enterprises, Inc., is a Tennessee corporation presently engaged in the business, inter alia, of holding and managing various investments. Prior to October 30, 1961, petitioner's business, then styled Fleetwood Coffee Company, was the sale of roasted coffee. It was one of 11 shareholders in Tenco, Inc., a corporation organized in 1951 to supply its shareholders with a reliable source of instant coffee for them to market under their own brand names. Tenco was financially successful over the years, and by 1959 had become the second largest producer of soluble coffee in the United States. Despite its financial success there was stockholder discontent.

Minute Maid Corporation had become by 1958 one of the nation's principal producers of frozen concentrated citrus juices. Because of financial reverses in 1957 Minute Maid decided to acquire other businesses in order to stabilize its income. Between January and July 29, 1959, Minute Maid submitted and the Tenco directors rejected three separate proposals for acquisition of Tenco stock. A fourth proposal was approved by the respective boards on August 25, 1959, and on September 3, 1959, petitioner and other Tenco shareholders signed an agreement with Minute Maid entitled "Purchase and Sale Agreement".

Pursuant to the Agreement providing for the sale of their Tenco stock to Minute Maid, the Tenco shareholders received a total consideration consisting of $3,000,000 in cash, $2,550,000 in promissory notes,¹ and 311,996 shares of Minute Maid stock valued at $5,771,926. Petitioner's share of the total consideration consisted of $281,564.25 in cash, $239,329.40 in promissory notes, and 29,282 shares of Minute Maid stock valued at $541,717. The Minute Maid stock received by Tenco stockholders represented 15.62 percent of the total outstanding Minute Maid shares, and constituted in excess of 50 percent of the total consideration received.

On December 10, 1959, the Minute Maid directors approved the November 24th recommendation of its general counsel to merge the company's four subsidiaries, including Tenco, into the parent company, and authorized that the merger be submitted to its stockholders for approval at a meeting scheduled for February 1960. Minute Maid's annual report to stockholders announced the merger plan about December 3, 1959. On January 5, 1960, Minute Maid requested a ruling from the Commissioner of Internal Revenue whether in the event of the proposed Tenco merger the basis of Tenco assets in Minute Maid's hands would be determined under section 334 (b) (2) of the Internal Revenue Code of 1954. This was approved by the Commissioner by ruling of February 25, 1960 that "Under the provisions of section 334(b) (2) that basis of the property received by Minute Maid upon the complete liquidation of Tenco will be determined by reference to the adjusted basis of the Tenco stock in the hands of Minute Maid." On April 30 and May 2, 1960, in accordance with the applicable state laws, Tenco and certain other subsidiaries were merged into Minute Maid.

On its income tax return for the fiscal year ended June 30, 1960, petitioner reported the cash and notes received as dividend income, subject to the 85 percent intercorporate dividends received deduction. The value of the Minute Maid stock received by petitioner was not reported, it being petitioner's position that such stock was received in connection with a nontaxable corporate reorganization. The District Director of Internal Revenue assessed a deficiency on the ground that the gain portion of the total consideration received (cash, notes, and Minute Maid stock) constituted taxable capital gain from the sale of a capital asset. Petitioner paid the deficiency, then sued here.

Petitioner contends that the transfer by the Tenco stockholders of their Tenco stock to Minute Maid in exchange for Minute Maid stock, cash and notes, followed by the merger of Tenco into Minute Maid, were steps in a unified transaction qualifying as a reorganization under section 368(a) (1) (A) of the 1954 Code. Consequently, petitioner continues, the Minute Maid stock was received by it pursuant to the plan of reorganization and is nontaxable as such, while the cash and notes received constitute a dividend distribution to which the 85 percent intercorporate dividends received deduction is applicable. The Government asserts that the transfer of Tenco stock to Minute Maid was an independent sales transaction; therefore, the entire gain realized by petitioner on the payment to it of cash, notes and Minute Maid stock is taxable as gain from the sale of a capital asset.

I The Reorganization Issue

The threshold issue is whether the transfer of Tenco stock to Minute Maid is to be treated for tax purposes as an independent transaction of sale, or as a transitory step in a transaction qualifying as a corporate reorganization. Significant tax consequences turn on which characterization is determined to be proper.

The general rule is that when property is sold or otherwise disposed of, any gain realized must also be recognized, absent an appropriate nonrecognition provision in the Internal Revenue Code.² One such nonrecognition provision, section 354(a) (1),³ provides in pertinent part:

No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization.⁴

By its terms, this exception to the general rule of taxation depends for its operation on the existence of a corporate reorganization. The term "reorganization", moreover, is a word of art in tax law and is specifically defined in section 368(a) (1) as comprising six types of transactions, exclusively.

If —

The premise of the corporate reorganization provisions is that certain transactions constitute corporate readjustments and are not the proper occasion for the incidence of taxation. Congressional policy is to free from tax consequences those corporate reorganizations involving a continuity of business enterprise under modified corporate form and a continuity of interest on the part of the owners before and after, where there is no basic change in relationships and not a sufficient "cashing in" of proprietary interests to justify contemporaneous taxation.

It is not disputed that there was a Type A reorganization in April 1960 when Tenco and Minute Maid were merged in accordance with state law. Nor does the Government dispute that Minute Maid continued the business of Tenco following the merger, or that the former Tenco shareholders had a continuity of interest in the enterprise by virtue of their ownership of stock in Minute Maid received in the exchange. The disagreement centers on whether the initial exchange of stock was a step in a unified transaction pursuant to a "plan of reorganization"

The underlying theory of the petitioner's claim is that the tax consequences of business transactions are properly determined by their substance and not by the form in which they are cast. Thus petitioner views the substance of the transaction under review to be an acquisition by Minute Maid of Tenco's assets in exchange for transferring Minute Maid stock, cash and notes to Tenco's stockholders. See Rev.Rul. 67-274, 1967-2 C.B. 141; Commissioner of Internal Revenue v. Dana, 103 F.2d 359 (3d Cir. 1939); George Whittell & Co., 34 B.T.A. 1070 (1936). The value of the Minute Maid stock received, which exceeded 50 percent of the total consideration, constituted a sufficient continuity of interest to support a Type A reorganization.⁵ Petitioner concludes, therefore, that the net result of the entire transaction is a reorganization, not to be altered by splitting the entire transaction into its component transitory steps....