King v. CIR

Decision Date07 April 1972
Docket NumberNo. 71-1418.,71-1418.
Citation458 F.2d 245
PartiesE. Ward KING and Myrtle C. King et al., Petitioner-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
CourtU.S. Court of Appeals — Sixth Circuit

John Y. Merrell, Annandale, Va., for appellants; Edwin O. Norris, Hunter, Smith, Davis, Norris, Waddey & Treadway, Kingsport, Tenn., on brief.

Richard Farber, Tax Div., Dept. of Justice, Washington, D. C., for appellee; Fred B. Ugast, Acting Asst. Atty. Gen., Meyer Rothwacks, Harry Baum, Attys., Tax Div., Dept. of Justice, Washington, D. C., on brief.

Before PHILLIPS, Chief Judge, and PECK and McCREE, Circuit Judges.

PECK, Circuit Judge.

This case involves the income tax liability for the year 1963 of the stockholders of the Mason & Dixon Lines, Inc., a motor common carrier of freight in interstate commerce. The facts of the case are fully set forth in the reported decision of the Tax Court, 55 T.C. 677, and disclose that Mason & Dixon, a Tennessee corporation formed in 1934, had been expanding rapidly since 1945 and by 1950 had outgrown its existing terminal facilities. It became apparent that new terminals would have to be constructed. The Interstate Commerce Act prohibited Mason & Dixon from borrowing the substantial funds it needed without prior ICC approval, a complex and extended procedure. Subsidiary corporations were therefore formed which were not subject to the jurisdiction of the ICC for the purpose of acquiring, improving, and leasing real estate to Mason & Dixon. The three subsidiary corporations involved in this action are Interstate Investment Corp., formed in 1950, Motorways Investment Corp., formed in 1953, and The Regal Corp., formed in 1956. Mason & Dixon owned all outstanding stock until October 4, 1963.

These corporations each served the same function, and each conducted its affairs in an identical manner. As Mason & Dixon required additional facilities, one of the subsidiary corporations would acquire the land, would accept a bid and enter into a contract with a general contractor for the construction of the terminal. In each case, the architect was engaged by Mason & Dixon. The subsidiary corporation would obtain a permanent loan secured by a first mortgage real estate note or a deed of trust to secure the debt on which it was the sole party obligor. Upon completion of the terminal, it was leased to Mason & Dixon.

In 1963, in order to facilitate a merger with Silver Fleet, Inc., an Indiana common carrier of freight, Mason & Dixon reorganized its operations to consolidate all carrier corporations in one group and all non-carrier corporations in another. This was accomplished by distributing all the stock of the three leasing corporations to the stockholders of Mason & Dixon, who then transferred all of this stock to Crown Enterprises, Inc. in exchange for voting stock of Crown, a wholly owned subsidiary of Mason & Dixon which had been formed in 1957 for the purpose of renting automotive equipment. The result of this distribution and exchange was that each of the three leasing corporations now enjoyed greater borrowing power by virtue of the fact that the common parent, Crown, could negotiate for all. The leasing corporations continued to operate in the same fashion as they had prior to the reorganization.

The stockholders reported this receipt of stock in their respective 1963 income tax returns as a transaction in which no gain or loss is recognized under § 355 of the Internal Revenue Code of 1954. The Commissioner determined that this distribution constituted a taxable dividend to the extent of the fair market value of the stock received by each taxpayer, and denied the claimed non-recognition of the distribution. The Tax Court sustained the Commissioner and concluded that the three subsidiary corporations were not engaged in the active conduct of a trade or business for the five year period prior to the date of the distribution, as required by § 355(b). Having so held, the Tax Court found it unnecessary to reach the Commissioner's alternative arguments that the subsidiaries were not engaged in the active conduct of a business immediately after the distribution and that the transaction had been used principally as a device for the distribution of the earnings and profits of the subsidiaries.1 The taxpayers have perfected this appeal from the decision of the Tax Court.

Section 355 of the Internal Revenue Code of 1954 provides an exception to the general rule that stock distributions by corporations are taxable to the shareholders. Distributions are so taxed to prevent corporations from moving undistributed income and earnings into the hands of stockholders who can dispose of them at capital gain rates instead of ordinary income rates. Congress recognized that there may be valid business reasons for the distribution of stock, and therefore provided that a distribution may go untaxed if the requirements of § 355 are met.

We start with the findings of the Tax Court that the subsidiary corporations were not shams, that there was no subterfuge, that the leasing corporations were organized to fulfill a valid business need of Mason & Dixon, that the leasing corporations adopted and followed the most advantageous method of doing business, that all rentals paid were customary within the industry and that the stock distribution and reorganization were also entered into for valid business reasons. The record shows that the subsidiary corporations performed all activities necessary to the operation of the real estate leasing business. Each subsidiary purchased land, negotiated with contractors for the construction of terminals, obtained loans, arranged for mortgages in favor of the lender, obtained insurance on the facilities, leased the terminals to Mason & Dixon, collected rentals, made payments of principal and negotiated for additions and alterations to terminals whenever necessary. In performing these and other functions, the subsidiaries acted and were dealt with as independent corporate entities by Mason & Dixon, as well as by contractors and subcontractors, bonding and insurance companies, bankers and other financial institutions, attorneys and local, state and Federal governmental agencies, including the Interstate Commerce Commission and the Internal Revenue Service.

Nevertheless, the Tax Court concluded that the subsidiaries had not actively conducted a trade or business because they performed these activities "in name only," principally because the officers of the subsidiary corporations were also officers of Mason & Dixon, and when these men acquired property, arranged financing and constructed the terminals they were acting on the ultimate behalf of Mason & Dixon. This conclusion was based upon the interdependence between Mason & Dixon and its subsidiaries, and we hold this conclusion to be violative of the principle that, especially for tax purposes, separate corporations, even parent and wholly owned subsidiary, must be treated as separate entities, no matter how closely they may be affiliated. The separate corporate entity may not be disregarded. Freedman v. United States, 266 F.2d 291 (6th Cir. 1959). In Taylor v. Commissioner of Internal Revenue, 445 F.2d 455 (1st Cir. 1971), the First Circuit said:

"Although federal courts have, on occasion upheld the Commissioner\'s disregard of a corporate entity, this has generally been done to prevent unfair tax avoidance. Only in situations where a corporation performs no function but the holding of title to real estate, have courts ignored the corporate entity." 445 F.2d at 457.

It is clear from the Tax Court's opinion that it disregarded the separate entities of the subsidiary corporations and based its conclusion upon the relationship of the subsidiary corporations to the distributing corporation. The record in this case discloses that the subsidiary corporations did far more than merely hold title to the terminal facilities which were leased to Mason & Dixon. In short, the record shows that the leasing corporations engaged repeatedly in construction projects of considerable magnitude, created substantial income producing rental properties and conducted all activities essential to the real estate leasing business. Even though the officers and directors of the leasing corporations were also officers and directors of Mason & Dixon, when they were performing activities in behalf of the leasing corporations they were in fact and in law acting solely for the leasing corporations.

The Tax Court considered that the fact that the leasing corporations had but one paid employee, an accountant, indicated strongly that no activities were being performed by the subsidiaries. However, the record clearly establishes that each subsidiary had four officers and at least four directors, all of whom rendered substantial services in acting for the subsidiaries.2

The Tax Court found that the net lease basis upon which properties were leased to Mason & Dixon represented pure passive income without the concomitant expenditure of money or effort on the part of the lessor. However, the Tax Court also found that the net leases represented the most advantageous method of doing business from the point of view of the leasing corporations, that the leases were bona-fide and of a type customarily used in the industry in long term situations and that the rentals paid were customary in the industry. The leasing of the terminal facilities represented the ultimate objective of the subsidiary corporations, but, as detailed above, it was far from the only activity conducted by them.

The findings of the Tax Court refute any contention that the subsidiaries were sham corporations or were mere contrivances for transferring corporate profits and properties. These corporations were not created to transfer corporate shares or anything of value to the taxpayers, were not terminated when their limited function had been exercised (as in Gregory v....

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