Seiberling Rubber Co. v. Commissioner of Internal Rev.

• Decision Date: 19 July 1948
• Docket Number: No. 10521.,10521.
• Citation: 169 F.2d 595
• Parties: SEIBERLING RUBBER CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Sixth Circuit

169 F.2d 595 (1948)

SEIBERLING RUBBER CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 10521.

Circuit Court of Appeals, Sixth Circuit.

July 19, 1948.

Robert Guinther, of Akron, Ohio, for petitioner.

Helen Goodner, of Washington, D. C. (Theron Lamar Caudle, Sewall Key, George A. Stinson and S. Walter Shine, all of Washington, D. C., on the brief), for respondent.

Before SIMONS, McALLISTER, and MILLER, Circuit Judges.

McALLISTER, Circuit Judge.

On March 31, 1934, petitioner, Seiberling Rubber Company, owned 3,772 shares of the 5,000 shares of common stock, and 250 shares of the 501 shares of the preferred stock, of Kemitex Products Co. As of the same date, the latter company owed an unsecured indebtedness to petitioner in the amount of $323,993.70.

Shortly thereafter, on April 3, 1934, petitioner addressed a letter to Kemitex Products Co., proposing the sale of all of the assets of Kemitex Products Co. to a new corporation, to be known as Kemitex Products, Inc., which would assume all of the indebtedness of the Kemitex Products Co., with the exception of $300,000.00 owing to petitioner. Furthermore, it was proposed that petitioner would accept all of the capital stock of the new company, and a note in the amount of $23,993.00 in full settlement of its claim of $323,993.00; that the new company would assume the indebtedness of the Kemitex Products Co. to all of its creditors having claims of $250.00 and over (except claims for taxes and purchase contracts), by giving specified promissory notes to such creditors; and would pay the lesser creditors in the ordinary course of business; and petitioner agreed in its letter that, if the proposal were carried out, it would give one share of common stock, out of the total common stock it received on the transaction, to each holder of a share of preferred stock in the old company, to the end that the preferred stockholders in the old company would have an opportunity to secure something for their investment. The proposal was accepted and the plan carried out as suggested by petitioner.

Several years later, in 1941, petitioner filed a tax return showing a loss of $296,622.22 on the sale of its Kemitex Products, Inc. stock. It further claimed a credit for excess profits tax because of a disallowed bad debt deduction. The Commissioner disallowed the claimed loss on petitioner's sale of its stock in Kemitex Products, Inc., and, further, denied the claim for credit for excess profits tax; and, on review, the Tax Court affirmed the determination of the Commissioner.

It is agreed that petitioner's claim with respect to its loss on the sale of its stock in Kemitex Products, Inc. depends upon whether the transaction whereby it secured the stock at the time of the organization of that company, was an exchange in which no gain or loss was recognizable under Section 112(b) (4) or (5) of the Revenue Act of 1932, 47 Stat. 169, as amended, 26 U.S.C.A. Int.Rev.Acts, page 511. Moreover, it is stipulated between the parties that if the determination of the Commissioner was erroneous with respect to the sale of the stock, an improper deduction was made in the amount of $296,622.22 from the accumulated earnings and profits account of petitioner for the tax year of 1941. The propriety of the Commissioner's determination with respect to the sale of the stock depends upon whether the transaction in question was an exchange in which no loss or gain is recognizable under the pertinent provisions of the statute.

There are, accordingly, two main questions before us: (1) whether the stock transaction in controversy was a tax-free exchange; and (2) whether a claimed bad debt deduction which was disallowed by the Commissioner was properly thereafter excluded by the Commissioner from petitioner's earnings and profits account on which a credit for excess profits tax was claimed. We come, then, to the first issue.

First Issue

It is contended by petitioner that the transactions between petitioner and the old and new Kemitex Corporations constituted a non-taxable reorganization under Sections 112(b) (4) and (5) of the Revenue Act of 1932, as amended.

We shall, at the outset, consider the objectives of these statutory provisions, as such indication of the legislative intent may illuminate their meaning and assist in their interpretation and application in this case.

The purpose of the statutory non-recognition of gain or loss from reorganization transactions, as indicated by the legislative history, was in part to prevent losses being established by bondholders, as well as stockholders, who received the new securities without substantially changing their original investment. The legislative history confirms the Congressional intent to cover reorganizations where the taxpayer's money is still tied up in the same kind of property as that in which it was originally invested. United Gas Improvement Co. v. Commissioner, 3 Cir., 142 F.2d 216. The reorganization provisions were enacted to free from the imposition of an income tax purely paper profits or losses where there is no realization of gain or loss in the business sense but merely the recasting of the same interests in a different form, the tax being postponed to a future date when a more tangible gain or loss is realized. This is recognized by the Treasury Regulations. They state that: "The purpose of the reorganization provisions * * * is to except from the general rule certain specifically described exchanges * * * which effect only a readjustment of continuing interests in property under modified corporate forms. Requisite to a reorganization under the Act are a continuity of the business enterprise under the modified corporate form, * * * continuity of interest therein on the part of those persons who were the owners of the enterprise prior to the reorganization." Commissioner of Internal Revenue v. Gilmore's Estate, 3 Cir., 130 F.2d 791, 794. These reorganization sections were enacted so that legitimate reorganizations, required in order to strengthen the financial condition of corporations, will be permitted. Since 1934, administrative interpretation of the reorganization section has limited its benefits to readjustments as are required by business exigencies and which are undertaken for reasons germane to the continuance of the business of a corporation, a party to the reorganization. Bazley v. Commissioner, 3 Cir., 155 F.2d 237, 242.

In determining whether Section 112(b) (4), hereinafter set forth, applies to the facts in this case, we must first decide whether the transaction in question amounted to a reorganization, as the above mentioned section of the statute which relates to non-recognition of gain or loss, applies only to reorganizations.

Section 112(i) of the Revenue Act in effect in 1934, 26 U.S.C.A. Int.Rev.Acts, page 513, at the time the changes in question were consummated, provided: "The term `reorganization' means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or part of its assets to another corporation if immediately after the transfer the transferor or its shareholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected."

Here, there was a transfer by the old Kemitex Products Co. of all of its assets to the new company, Kemitex Products, Inc. The petitioner, Seiberling Rubber Company, had been the owner of 3,772 shares of the 5,000 shares of common stock of the old Kemitex Products Co. When the transfer from the old company to the new company was made, petitioner became the owner of all 5,000 shares of the common stock of the new company.¹

Respondent insists that petitioner received its stock in the new company in its capacity as a creditor of the old corporation and that there was no continuation of petitioner's status of stockholder for the reason that, because of the insolvency of the old corporation, such relationship as stockholder no longer existed. It is, therefore, contended that there was no reorganization, because petitioner was in control after the transfer only as creditor and not because of its prior stockholding interest. This fact, declares respondent, prevents the transaction from coming within the definition of a reorganization as set forth in the statute, inasmuch as petitioner, as stockholder of the old corporation, was not in control of the new corporation. However, it makes no difference whether control was retained by the old stockholders, in their capacity as such stockholders, or because of the fact that they were creditors. It is enough that the persons having control of the new company were former stockholders, although they received the stock in the new corporation resulting from the reorganization in their capacity as creditors of the old company. Prairie Du Chien-Marquette Bridge Co. v. Commissioner, 3 Cir., 142 F.2d 624. See to the same effect Commissioner of Internal Revenue v. Huntzinger, 10 Cir., 137 F.2d 128.

In the instant case, moreover, it is to be again emphasized that petitioner, as stockholder, was in control of the old corporation up to the time of reorganization, and, as a result of the reorganization, continued in control of the new corporation. It is our conclusion that the transaction in controversy amounted to a reorganization under Section 112(i) (B), as above set forth, since there was the transfer by a corporation of all of its assets to another corporation, and immediately after the transfer, the stockholders of the old transferring corporation were in control of the new corporation to which the assets had been transferred; and it is unimportant that,...