United States v. Adkins-Phelps, Incorporated

• Decision Date: 30 September 1968
• Docket Number: No. 18944.,18944.
• Citation: 400 F.2d 737
• Parties: UNITED STATES of America, Appellant, v. ADKINS-PHELPS, INCORPORATED, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

400 F.2d 737 (1968)

UNITED STATES of America, Appellant, v. ADKINS-PHELPS, INCORPORATED, Appellee.

No. 18944.

United States Court of Appeals Eighth Circuit.

September 30, 1968.

Stuart A. Smith, Atty., Dept. of Justice, Washington, D. C., for appellant; Mitchell Rogovin, Asst. Atty. Gen., Dept. of Justice, Lee A. Jackson and Harry Baum, Attys., Dept. of Justice, Washington, D. C., and W. H. McClellan, U. S. Atty., Little Rock, Ark. on the brief.

William H. Bowen and Byron M. Eiseman, Jr., of Smith, Williams, Friday & Bowen, Little Rock, Ark., for appellee.

Before VAN OOSTERHOUT, Chief Judge, HEANEY, Circuit Judge, and REGISTER, Chief District Judge.

VAN OOSTERHOUT, Chief Judge.

This is a timely appeal from final judgment of the District Court awarding Adkins-Phelps, Incorporated (taxpayer), $40,689.38 and interest as a refund of income tax of taxpayer for the fiscal year ending September 30, 1961, alleged to have been unlawfully assessed and collected. Adkins-Phelps, Incorporated, an Arkansas corporation, acquired the assets of J. F. Weinmann Milling Company (Weinmann), also an Arkansas corporation, through corporate reorganization procedures effected on November 11, 1959, which were admittedly in conformity with Arkansas law.

On the date of the reorganization, Weinmann had an unused net operating loss of $602,420.34. Taxpayer in its income tax return for the fiscal year ending September 30, 1961, absorbed its $88,825.73 income completely by offsetting pre-merger losses of Weinmann. The Commissioner disallowed the loss deduction, which resulted in the deficiency assessment of $40,689.38 here involved. The taxpayer, after paying such assessment, filed timely claim for refund which was disallowed, whereupon this action was commenced. Jurisdiction is established.

This case was tried before a jury. The only verdict returned by the jury was a response to a special interrogatory which was answered by the jury as follows: "That the plaintiff did not effect a merger with J. F. Weinmann Milling Company for the principal purpose of tax avoidance." Instructions given the jury and exceptions thereto, if any, are not set out in the printed record. It would appear that the question answered by the special interrogatory was the only issue submitted to and determined by the jury. Nothing in the record or briefs indicates any objection was made to such a limited submission. Upon the basis of the special verdict, the court on December 22, 1966, entered judgment for the taxpayer for the amount of the refund claimed.

Thereafter on December 28, 1966, the Government filed a motion for judgment n. o. v. upon the following grounds:

"1. The evidence shows as a matter of law that the acquisition of J. F. Weinmann Milling Company assets by the plaintiff was not a transfer to which Section 361 of the Internal Revenue Code of 1954 applies, because the transfer was not in connection with a reorganization of the type enumerated in Section 381(a) (2) of the Internal Revenue Code of 1954. As a consequence, the plaintiff is not entitled to succeed to and take into account the net operating losses of J. F. Weinmann Milling Company;

"2. The receivership proceedings so changed the J. F. Weinmann Milling Company insofar as its capital structure, debt structure, and equity ownership were concerned that neither it nor a successor by statutory merger could thereafter utilize pre-receivership net operating losses as a basis for a post-receivership net operating loss deduction; and

"3. The evidence is such that reasonable men could only find and conclude that the principal purpose for which the property of J. F. Weinmann Milling Company was acquired by the plaintiff was the avoidance of Federal income tax by securing the benefit of a deduction which the plaintiff would not otherwise enjoy."

The trial court on February 23, 1967, denied such motion in its entirety, setting forth its reasons therefor in an accompanying memorandum opinion. This appeal is from the judgment entered and from the order denying the motion for judgment n. o. v.

The third ground of the motion, which relates to the sufficiency of the evidence to support the jury finding that the merger was not for the principal purpose of tax avoidance, has been abandoned by the Government in this appeal and is not before us.¹ Thus the finding of the jury that the principal purpose of the merger was not tax avoidance stands.

The Government upon this appeal asserts it is entitled to a reversal for the following reasons:

1. No corporate reorganization within the meaning of § 368(a) (1) (A), I.R.C. 1954, (26 U.S.C.A. § 368(a) (1) (A)² exists because the continuity of interest requirement was not met.

(a) The Adkins-Phelps stock ac-acquired by Mrs. Weinmann pursuant to the merger agreement did not represent a substantial proprietary interest.

(b) Insolvency of Weinmann completely wiped out all stockholders\' equity in that corporation.

2. No § 368(a) (1) (A) reorganization exists because the continuity of business enterprise requirement was not met.

Section 381 provides that in the case of precisely defined types of corporate acquisition certain tax items of a transferor corporation as of the date of the transfer shall be taken into account by the acquiring corporation for income tax purposes. Among such items is the net operating loss carry-over, subject to the conditions imposed by § 381(c) (1).³

In order for a corporate acquisition to qualify for survival of loss carry-overs to the succeeding corporation, it must be one of the tax-free types set out in § 381(a). Included in the qualifying category is a transfer to which § 361 applies "but only if the transfer is in connection with the reorganization described in subparagraph (A) * * * of section 368(a) (1)." Section 368(a) (1) (A), primarily relied upon by taxpayer, includes in the definition of reorganization, "(A) a statutory merger or consolidation."⁴

The Government does not contend that the Arkansas laws governing merger or consolidation have not been complied with. The parties agree that the compliance with state merger or consolidation statutes standing alone is not sufficient to satisfy the requirements of § 368(a) (1) (A). In addition, under the judicial gloss put upon the statute by the courts in light of the legislative history and purpose, a showing of continuity of interest is required. Such requirement is summarized in Southwest Natural Gas Co. v. Commissioner, 5 Cir., 189 F.2d 332, 334, as follows:

"(1) that the transferor corporation or its shareholders retained a substantial proprietary stake in the enterprise represented by a material interest in the affairs of the transferee corporation, and (2) that such retained interest represents a substantial part of the value of the property transferred."

See LeTulle v. Scofield, 308 U.S. 415, 60 S.Ct. 313, 84 L.Ed. 355; Helvering v. Minnesota Tea Co., 296 U.S. 378, 56 S.Ct. 269, 80 L.Ed. 284; John A. Nelson Co. v. Helvering, 296 U.S. 374, 56 S.Ct. 273, 80 L.Ed. 281; Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462, 53 S.Ct. 257, 77 L.Ed. 428; Cortland Specialty Co. v. Commissioner, 2 Cir., 60 F.2d 937; Treasury Regulations § 1.368-1(b); Mertens Law of Federal Income Taxation § 20.59.

The trial court, as a basis for its determination that the continuity of interest requirement has been met, states:

"The plan of reorganization called for an exchange of stock on a share-for-share basis between Adkins-Phelps and the stockholders of Weinmann.

The result of this exchange was that Mrs. Weinmann, who held 99% of the Weinmann stock, owned approximately one-sixth of the outstanding stock of Adkins-Phelps. In addition to being the principal shareholder, Mrs. Weinmann was also one of the largest creditors of Weinmann. We think, however, that it is immaterial whether Mrs. Weinmann occupied her position as an equity owner of Weinmann in her capacity as principal shareholder or as a creditor. The fact that she maintained a substantial equity interest in Adkins-Phelps subsequent to the merger we consider to be sufficient to meet the continuity of interest requirement, and we so hold."

Such finding and holding is supported by substantial evidence and is not clearly erroneous.

The Government does not seriously contend that a one-sixth stock interest would not be sufficient to establish continuity of interest. Principal reliance is placed upon a portion of the merger agreement reciting that the par value of Adkins-Phelps stock is $1.00 per share and the provision granting a stock option, which reads: "that for and as part of the consideration of the merger that the stockholders of the consolidated corporation, continuing under the name of Adkins-Phelps, Inc., bind themselves and agree that each stockholder will not transfer his, her or its capital stock in the Adkins-Phelps, Inc., corporation without first offering said stock to Adkins-Phelps, Inc., for par value."

The Government contends that by reason of the foregoing agreement all attributes of stock ownership are absent in the 997 shares of stock acquired by Mrs. Weinmann in the merger and that Mrs. Weinmann's stock interest could never be worth more than its $997 aggregate par value.

Such argument lacks validity for the reasons hereinafter set out:

1. Mrs. Weinmann, except for the sale restriction if valid, possessed all rights of a stockholder, including the right to vote the stock, the right to receive distribution of profits realized in the form of cash or stock dividends, preemptive rights to a proportionate share of any new stock issued, and a right to pledge the stock as security. Such rights are substantial attributes of stock ownership.

2. The agreement placed Mrs. Weinmann under no obligation to sell the stock to the other shareholders. She had a complete right to continue to hold the stock. The Government contends that by reason of her age of 82 years, with a life expectancy of about 4 years, that...