Penn-Dixie Steel Corp. v. Comm'r of Internal Revenue

• Citation: 69 T.C. 837
• Decision Date: 27 February 1978
• Docket Number: Docket No. 4097-75.
• Parties: PENN-DIXIE STEEL CORPORATION (AS SUCCESSOR TO CONTINENTAL STEEL CORPORATION), PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

69 T.C. 837

PENN-DIXIE STEEL CORPORATION (AS SUCCESSOR TO CONTINENTAL STEEL CORPORATION), PETITIONER

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 4097-75.

United States Tax Court

Filed February 27, 1978.

1. In 1968, Union and Continental entered into an agreement to form a new corporation, Phoenix. Continental contributed cash and received 50 percent of Phoenix's stock. Union contributed the assets and liabilities of Old Phoenix, one of its divisions, and received 50 percent of Phoenix's stock and a debenture of Phoenix. Union was given the right to put its stock in Phoenix to Continental on set terms during the period Aug. 1, 1970 to July 31, 1971, and Continental was given the right to call Union's stock in Phoenix on the same terms during the period Aug. 1, 1971 to July 31, 1972. Union exercised its put effective July 31, 1971. Held, the 1968 agreement did not constitute a sale with a deferred payment of Union's entire interest in Old Phoenix, with the result that Continental is not entitled to a deduction for imputed interest for its fiscal year ended Jan. 1, 1972, under sec. 483, I.R.C. 1954, as amended.

2. Continental acquired pollution control facilities and stated on its tax return, for its fiscal year ended Jan. 1, 1972, that it elected to amortize the expenditure therefor under the provisions of sec. 169, I.R.C. 1954, as amended. At the time of filing its return, it had not applied for certification of said facilities. Held, the election is invalid. John Y. Taggart and Mel Jack Duksin, for the petitioner.

Powell W. Holly, Jr., for the respondent.

TANNENWALD, Judge:

Respondent determined a deficiency of $574,795 in the Federal income tax for the taxable year ending January 1, 1972, of petitioner's predecessor.

The issues remaining for our decision are: (1) Whether a 1968 transaction between petitioner's predecessor and another corporation constituted a sale with a deferred payment, entitling the predecessor to a deduction for imputed interest under section 483;¹ and (2) whether the predecessor's failure fully to comply with respondent's regulations precludes qualification for rapid amortization of pollution control facilities under section 169.

FINDINGS OF FACT

Some of the facts have been stipulated by the parties and are incorporated herein by this reference.

The petitioner, Penn-Dixie Steel Corp. (petitioner), is the successor by merger on May 11, 1973, to Continental Steel Corp. (Continental). It had its principal place of business of Kokomo, Ind., at the time of the filing of the petition herein. The return for the year in question was filed with the Internal Revenue Service Center, Memphis, Tenn., on September 18, 1972. An amendment to that return to submit certain pollution control data was filed on April 3, 1975, with the same Service Center.

Phoenix Manufacturing Co. (Old Phoenix), a division of Union Tank Car Co. (Union), was engaged in the business of producing bars reinforcing concrete and merchant bar products such as flats, rounds, angles, channels, and squares. A continuous supply of steel billets was essential to this business. Continental, which manufactured and sold steel products, including billets, rods, merchant bars, nails, fences, welded fabric, and a variety of industrial wire sizes and finishes, had an excess of semifinished steel in the form of steel billets. Old Phoenix could guarantee a permanent market for that excess steel.

Continental and Union entered an agreement entitled “Joint Venture Agreement” on July 1, 1968, which closed on July 31, 1968. Pursuant to this agreement, a new corporation named Phoenix Manufacturing Co. (Phoenix) was formed. Union transferred to Phoenix assets and liabilities of Old Phoenix having a net value of $17 million in exchange for 50 percent of the stock and an $8.5 million 7-percent debenture due July 31, 1974. Continental made a capital contribution of $8.5 million to Phoenix and received 50 percent of the stock. The treasurer of Phoenix was to invest and reinvest this cash in the highest yielding securities consistent with safety and the maturity date of the Phoenix debenture held by Union. In addition, Continental agreed to enter into a supply contract with Phoenix.

The July 1, 1968, agreement also provided for a put and call. During the period August 1, 1970, to July 31, 1971, Union could put to Continental its Phoenix stock for $8.5 million plus 125 percent of one-half the undistributed profits. Continental could call Union's stock in Phoenix on the same terms during the following year, beginning August 1, 1971, and ending July 31, 1972. The provision regarding undistributed profits was intended to operate as a penalty if profits were not distributed. If neither the put nor call were exercised, both parties would have a right of first refusal to the other party's stock in Phoenix.

Continental would have preferred an outright purchase of Old Phoenix, but Union was unwilling to modify the basic structure of its proposal. Union had considered selling Old Phoenix, but had rejected that option in favor of the joint venture structure in order to (1) avoid capital gains tax by qualifying for tax-free treatment under section 351 and (2) gradually phase in the decline in earnings resulting from the loss of Old Phoenix. Continental accepted Union's terms because Old Phoenix was so well suited to Continental's needs.

The Phoenix board of directors was composed of three representatives of Continental (its president, vice president and treasurer, and secretary) and three representatives of Union (its president and two high-level executives). The secretary of Phoenix was also the secretary of Continental and the treasurer of Phoenix was also the treasurer of Union.

Sometime after July 31, 1968, Penn-Dixie acquired control of Continental. Because Union was concerned that Penn-Dixie was in poor financial condition, its treasurer caused Phoenix as of November 23, 1970, to invest in an $8.5 million 83;4-percent debenture due July 31, 1974, issued by Union.

On February 24, 1971, Continental, Union, and Phoenix executed a supplement to the joint venture agreement of July 1, 1968, and an escrow agreement. Pursuant thereto, Union exercised its put, thereby transferring its 50-percent stock interest in Phoenix to Continental, effective July 31, 1971. Continental purchased the stock by the following series of transactions. The $8.5 million Union 83;4-percent debenture due July 31, 1974, was modified to provide, among other things, for 7-percent interest (83;4 percent prior to February 1, 1971) and a due date of July 31, 1971. Continental executed an interest-free promissory note, in the principal amount of $8.5 million, payable to Phoenix on July 31, 1974, and Phoenix agreed to accept said note in full satisfaction of the modified $8.5 million Union debenture. The net effect of the foregoing transactions was that Phoenix held Continental's $8.5 million note and Continental owned 100 percent of the Phoenix stock. Union continued to hold the $8.5 million Phoenix debenture issued on the original incorporation of Phoenix.

During the taxable year ending January 1, 1972, Continental expended $379,140 for pollution control facilities. Continental purported to make an election to amortize these facilities under section 169, attaching a statement to that effect to its return for such taxable year together with a letter from the Indiana Stream Pollution Control Board dated May 19, 1970, approving the plans and specifications of Continental's pollution control facilities and a letter of June 24, 1971, to the Indiana State Board of Health describing said facilities and their characteristics and reporting on the progress made in putting them into operation. Continental did not attach a statement that the facilities had been certified by the Federal certifying authority or a statement that application had been made to the proper certifying authorities and copies of any such applications. Such applications had not then been made and were not made until early 1973. The United States Environmental Protection Agency application forms were not available until at least 1 year after the final promulgation of the Treasury regulations under section 169 on May 21, 1971.

Certification was received from the Stream Pollution Control Board of the State of Indiana on October 24, 1973, and from the Environmental Protection Agency on November 5, 1973. These documents were brought to the attention of the Internal Revenue Service Appellate Conferee on March 4, 1974, or April 25, 1974. On March 31, 1975, petitioner filed an amended Federal income tax return, supplying copies of the Federal certification and application therefor and the State certification.

OPINION

The first issue is whether the 1968 transaction between Union and Continental constituted a sale to Continental of Union's entire interest in Old Phoenix with payment of one-half the purchase price deferred for 2 or 3 years. The parties agree that if it was a sale, Continental is entitled to an imputed interest deduction of $1,170,450 under section 483. Petitioner, while conceding that Continental's 1968 transaction with Union did not constitute a sale for commercial purposes, contends that it nevertheless constituted a sale for tax purposes in that it shifted the burdens and benefits of full ownership from Union to Continental. Cf. Merrill v. Commissioner, 40 T.C. 66, 74 (1963), affd. per curiam 336 F.2d 771 (9th Cir. 1964).

It cannot be gainsaid that, in form, the transaction herein did not constitute a sale. Rather, it envisaged the creation of a corporation, intended to satisfy the requirements of section 351, to which assets and liabilities of Old Phoenix and $8.5 million cash from Continental were transferred in exchange for stock and a debenture and in which the equity ownership was given to Continental and Union equally. By the terms of the 1968 agreement, ultimate ownership of the...