The South Bay Corporation v. CIR

• Decision Date: 19 May 1965
• Docket Number: Docket 29349.,No. 342,342
• Citation: 345 F.2d 698
• Parties: THE SOUTH BAY CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

345 F.2d 698 (1965)

THE SOUTH BAY CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 342, Docket 29349.

United States Court of Appeals Second Circuit.

Argued March 11, 1965.

Decided May 19, 1965.

COPYRIGHT MATERIAL OMITTED

Robert J. Casey, New York City (Clark, Carr & Ellis and Thomas E. Tyre, New York City, of Counsel), for petitioner.

Jonathan S. Cohen, Washington, D. C. (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson and Harry Baum, Dept. of Justice, Washington, D. C., on the brief), for respondent.

Before SMITH and MARSHALL, Circuit Judges, and DOOLING, District Judge.*

DOOLING, District Judge:

The South Bay Corporation petitions to review a decision of the Tax Court that disposed of three issues all of which arose out of the 1951 condemnation of all petitioner's water service properties and franchises by the Suffolk County Water Authority.

The Tax Court first decided that petitioner had acquired the properties of two water companies in 1925 in connection with reorganizations; that, in consequence, the properties had for petitioner the same basis that they had in the hands of the transferor corporations; and that, therefore, the gain petitioner realized when the Suffolk County Water Authority condemned the properties in 1951 should be determined by limiting petitioner to its transferors' basis for the properties. The decision of the Tax Court on this issue is reversed, on the ground that the transactions were purchases of properties and not acquisitions in connection with reorganizations, and the case is remanded for further proceedings consistent with this opinion.

The Tax Court decided, on the second issue, that petitioner had failed to establish the basis of intangible properties which petitioner bought along with tangible properties at global, unallocated prices from three other water companies in 1925 and 1927, and that petitioner had also failed to negate the existence of adjustments to any basis that did exist; the Tax Court increased petitioner's taxable gain on the condemnation in the amount of alleged cost of the intangibles. (The same point is involved as to the properties allegedly acquired in connection with reorganizations.) The decision of the Tax Court on this second issue is reversed and the case is remanded to the Tax Court for further proceedings consistent with this opinion.

The Tax Court decided, as to the third issue, that an amount which petitioner received from Suffolk County Water Authority in the condemnation in exchange for the surrender of petitioner's right to apply for a refund of real estate taxes that petitioner had prepaid constituted ordinary taxable income to the petitioner and was not a part of the sales price in condemnation of the properties transferred. The decision of the Tax Court on the third issue is affirmed.

I The Reorganization Issue

In 1925 petitioner and four other water companies in Suffolk County were merged on the initiative of Francis W. Collins. Before the series of transactions involved, Collins had no interest whatever in any of the water companies and at the completion of the transactions Collins owned a majority of the common stock and control of petitioner, and petitioner had acquired all of the assets, tangible and intangible, of the four other Suffolk County water companies. Two years later in another transaction petitioner acquired a fifth water company. As to three of the water companies, Port Jefferson Water Company, Amityville Water Works Company and Kings Park Water Company, there is no question that petitioner bought their properties for cash, preferred stock issued at par and petitioner's assumptions of the liabilities of the transferor corporations. The "reorganization" question is raised in respect of the acquisitions of the other two companies.

Petitioner acquired the properties of the other two companies, Great South Bay Water Company and Southampton Water Works Company, on June 19, 1925. Collins owned a majority interest in and control of the stock of the transferor corporations just before the transfers of properties to petitioner. Immediately after the transfers, as before them, Collins had a majority interest in and control of petitioner. The argument is that the transactions were reorganizations within § 203(h) (1) (A) of the Revenue Act of 1924 (43 Stat. 257) since "reorganization" includes 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 of the properties of another corporation, and since the requisite "continuance of interest * * * in the properties transferred" existed in Collins' continuing and augmented majority stock interest in and control of petitioner. Cortland Specialty Co. v. Commissioner of Internal Revenue, 2d Cir. 1932, 60 F.2d 937, 940; cf. Pinellas Ice & Cold Storage Co. v. Commissioner of Internal Revenue, 1933, 287 U.S. 462, 470, 53 S.Ct. 257, 77 L.Ed. 428. The necessary consequence, it is argued, is that under the provisions of § 113(a) (7) of the Internal Revenue Code of 1939 (53 Stat. 40) petitioner's basis for the properties is the basis of the properties in the hands of the transferor corporations, because the properties were acquired "in connection with a reorganization" and immediately after the transfer an interest or control in the property of 50% or more remained in the same persons or any of them, that is, remained in Collins. Certainly if Collins, owning controlling interests in three companies, merged them into one surviving corporation which he continued to control, the transaction would be a reorganization and the basis of the assets of the disappearing corporations would carry forward without gain or loss recognition on the transfer to the surviving company.

The present transactions, however, were not reorganizations because Collins' ownership of the controlling stock of the transferor corporations was a transitional step in a many termed transaction that did not simply unite the properties of the three companies but also changed the ultimate ownership of the properties rather than continued them in the same ownership.

The facts about the transactions themselves as distinguished from their purpose and effect were entirely, if imperfectly, stipulated. Collins got an option on two-thirds of the stock of Southampton Water Works Company in November 1924, and between November 21, 1924, and April 9, 1925, he bought all of the stock of petitioner. On the latter date he became president and a director of petitioner. Meanwhile Collins had contracted, on February 28, 1925, to buy for cash, for delivery on May 15, 1925, 40% of the common and about 29% of the preferred stock of Great South Bay Water Company, and in the same contract Collins agreed to buy the shares of any other shareholders of Great South Bay Water Company. By April 14, 1925, Collins had 81% of the common and 59% of the preferred stock of Great South Bay.

On April 14th petitioner made a letter offer to the stockholders of Great South Bay to acquire their stock in exchange for preferred stock of petitioner and a cash bonus. Since Collins already owned 81% of Great South Bay's common stock and 59% of its preferred stock on the day the letter was sent, the offer was very largely made to him. (The offer was apparently available to those stockholders of Great South Bay who had already deposited their stock in acceptance of the cash offer earlier made.) On April 21st petitioner authorized its officers to offer to acquire from Great South Bay all of its properties subject to an outstanding bond issue of $400,000 in consideration of petitioner's assuming all the debts of Great South Bay and paying to Great South Bay or to its stockholders a cash amount for each share of its preferred and common stock, that offer to be alternative to the offer made by the letter of April 14th to issue petitioner's preferred stock and to pay a cash bonus for the Great South Bay stock. Whatever was contemplated, as the Tax Court has pointed out the transaction was consummated on a basis different from both the offers disclosed in the stipulation of facts.

On June 19, 1925, petitioner had acquired all the Great South Bay stock and on that day petitioner acquired all the assets of Great South Bay and issued in exchange 6,650 shares of its own common stock, 3,377.6 shares of preferred stock and $750,000 of its own bonds, and, in addition, petitioner took the assets subject to a bond issue of $400,000, assumed liabilities in the amount of $508,174 and paid cash of $36,668.

On June 1, 1925, Collins offered to sell to the petitioner the two-thirds of the total shares of Southampton Water Works Company stock, on which he still had only an option, in exchange for petitioner's bonds and preferred stock, and also to transfer some cash to the petitioner; that offer was accepted by the petitioner on the same day. On the same day the petitioner offered to purchase from Southampton all of its assets, to assume all its debts and to pay to it or on its order to its stockholders cash and preferred stock of petitioner measured by the amount of Southampton's outstanding stock.

On June 19th, Collins acquired the Southampton stock and on the same day petitioner acquired that stock from Collins and acquired all of the rest of the Southampton stock from its other stockholders. On the same day petitioner acquired all Southampton's assets, assumed all its liabilities and issued petitioner's own bonds and preferred stock in payment.

At the close of June 19th, then, Collins was in control of petitioner and petitioner had acquired all the properties of Great South Bay and Southampton.

The Tax Court was satisfied that Collins planned from the outset to bring about the mergers and remain in control of the continuing corporation (41 T.C. at 903) and that, after getting the November...