United States v. El Pomar Investment Company

• Decision Date: 23 April 1964
• Docket Number: No. 7342.,7342.
• Citation: 330 F.2d 872
• Parties: UNITED STATES of America, Appellant, v. EL POMAR INVESTMENT COMPANY, Appellee.
• Court: U.S. Court of Appeals — Tenth Circuit

330 F.2d 872 (1964)

UNITED STATES of America, Appellant, v. EL POMAR INVESTMENT COMPANY, Appellee.

No. 7342.

United States Court of Appeals Tenth Circuit.

April 23, 1964.

Phillip Miller, Atty., Dept. of Justice, (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, I. Henry Kutz, Karl Schmeidler, Attys., Dept. of Justice, Lawrence M. Henry, U. S. Atty., and Merle R. Knous, Asst. U. S. Atty., on the brief), for appellant.

Ben S. Wendelken, Colorado Springs, Colo. (Murray, Baker & Wendelken, Colorado Springs, Colo., of counsel, on the brief), for appellee.

Before MURRAH, Chief Judge, and PHILLIPS and PICKETT, Circuit Judges.

ORIE L. PHILLIPS, Circuit Judge.

This is an action to recover on a tax refund claim. It involves the question of whether deficits of predecessor corporations were carried over to successor corporations, which acquired the assets of their respective predecessors through tax-free reorganizations, with the result that earnings and profits of the last successor corporation realized after the last reorganization, but prior to 1951, retained by it until 1951, and in that year distributed to stockholders constituted a return of capital, rather than a dividend, taxable under § 115(a) of the Internal Revenue Code of 1939, 26 U.S.C. § 115(a).

El Pomar Investment Company,¹ a Colorado corporation, is the taxpayer involved. From a judgment in favor of Pomar for $2,621.65, with interest, the United States has appealed.

The case was tried on a written stipulation and the exhibits attached thereto, filed by the parties, from which the following facts appear:

Pomar was a stockholder in the Garden City Company,² a Colorado corporation. During the year 1951, it distributed to its stockholders $117,477. Pomar received $67,539 thereof and reported it in its income tax return for 1951 as dividend income and paid the tax thereon. Thereafter, it filed a timely claim for refund of $2,832.13 on the ground that 45.72967 per cent of the amount received by it, or $30,885.36, was a dividend from earnings of Colorado-Garden City and 54.27033 per cent thereof, or $36,653.64, was a return of capital and not taxable. The claim was disallowed and Pomar then brought this action to recover on its claim for refund.

On April 2, 1919, Garden City Sugar and Land Company, a corporation, had outstanding First Mortgage and Refunding Bonds of the face value of $2,224,750; Real, Chattel, and Collateral Trust Bonds of the face value of $2,500,000; and 25-Year Income Bonds of the face value of $685,000. It did not have sufficient cash to pay the interest on the First Mortgage and Refunding Bonds, which had become due January 1, 1919, and had neither funds nor credit through which it could obtain funds to pay the installments of interest on the First Mortgage and Refunding Bonds and the Real, Chattel, and Collateral Trust Bonds, respectively, to accrue and become due July 1, 1919, and it was without funds or credit to finance its farming operations for the current year. A bondholders' committee was created and a plan evolved and reduced to writing for the adjustment of such securities and the establishment of adequate credit with which to provide the necessary working capital for the operations of the current year. Acceptance of the plan was obtained and the bonds were transferred to and deposited with the bondholders' committee.

On October 10, 1919, the bondholders' committee obtained a decree of foreclosure against the Sugar and Land Company in the District Court of Finney County, Kansas. In January, 1920, the committee caused the Garden City Company, a Delaware corporation, and the first successor corporation to be organized.³ The committee purchased all the property of the Sugar and Land Company at the foreclosure sale had pursuant to such foreclosure decree and transferred all of such property to Delaware-Garden City in exchange for its bonds, having a face value of $4,250,000, and its entire issue of stock, being 100,000 shares of no par value common stock. The new bonds were made inferior to a working capital loan, which was not to exceed $500,000.

During the period January 1, 1914, to January 1, 1920, the Sugar and Land Company had a cash operating deficit of $714,360.46 and an allowed depreciation deficit of $500,024.51, or an aggregate of $1,214,384.97.

At the time Delaware-Garden City was organized, it had neither accumulated earnings nor deficits from operations, except such accumulated earnings or deficits as were carried over from the Sugar and Land Company.

Delaware-Garden City carried on the same kind of business at the same place and with the same property as had the Sugar and Land Company.

On August 15, 1929, $3,980,417.50 of income bonds of Delaware-Garden City, secured by a mortgage on its property, were issued and outstanding.⁴ No interest had been paid on such bonds. On January 1, 1930, all of the principal of such bonds and accrued interest thereon would mature and be payable. Delaware-Garden City was not financially able to pay such principal and interest and a readjustment of the capital financial structure of the company was unavoidable. Aside from the amounts due on such bonds for principal and interest, Delaware-Garden City was in good financial condition and had quick assets of over $500,000, consisting largely of cash and sugar in storage. It was necessary to retain such quick assets in order to finance the current operations of Delaware-Garden City and keep it a going concern, but such assets were sufficient to provide it or a reorganized company with adequate working capital. Aside from the bond indebtedness, Delaware-Garden City had no substantial indebtedness, even for current bills.

Thereafter, pursuant to a plan of reorganization, the following events took place:

On August 15, 1929, a bondholders' committee was created by the holders of income mortgage bonds of Delaware-Garden City; such bondholders transferred such income-mortgage bonds to the 1929 bondholders' committee; the 1929 bondholders' committee obtained a decree of foreclosure of Delaware-Garden City's mortgage securing its income bonds; on November 6, 1930, it organized Colorado-Garden City; and on November 14, 1930, it acquired all of the property of Delaware-Garden City at a foreclosure sale under such decree of foreclosure and caused the same to be transferred to Colorado-Garden City in exchange for all of its authorized common stock, which the bondholders' committee caused to be issued to the bondholders of Delaware-Garden City.

Colorado-Garden City carried on the same kind of business at the same place and with the same property that had been carried on by Delaware-Garden City.

During the period January 1, 1920, to November 17, 1930, Delaware-Garden City had accumulated a total deficit of $2,931,197.02, which included accrued and unpaid interest on income bonds of $2,540,668.28.

At the time Colorado-Garden City acquired all of the assets from the bondholders' committee, it had neither accumulated earnings nor deficits from operations, except such accumulated earnings or deficits as might have been properly carried over from Delaware-Garden City and the Sugar and Land Company.

For the fiscal year ending February 29, 1952, Colorado-Garden City had earnings and profits available for distribution in the amount of $56,843.47, without any deduction for cost depletion; and for the same year had undistributed earnings and profits realized during prior years in the amount of $348,222.54, after payment of dividends in previous years, but before taking into account operating deficits of Delaware-Garden City and the Sugar and Land Company.

On each reorganization all of the debts owing to creditors of the predecessor corporation, other than bond indebtedness, were assumed and paid in full by the successor corporation.

On the first reorganization all of the stock of the successor corporation, Delaware-Garden City, was issued to holders of 25-Year Income Bonds and of Real, Chattel, and Collateral Trust Bonds issued by the predecessor corporation, the Sugar and Land Company, but not qua stockholders in the predecessor.

On the second reorganization all of the stock of the successor corporation, Colorado-Garden City, was issued to the several holders of outstanding bonds issued by the predecessor corporation, Delaware-Garden City, each of such bondholders receiving shares of such stock on the basis of his proportionate interest in the whole of such bonds. Thus, on the second reorganization there was a continuity of stock ownership, although certain bondholders of Delaware-Garden City, who may not have been stockholders in it, became stockholders in Colorado-Garden City. While technically the foreclosure on each reorganization wiped out the interests of unsecured creditors and stockholders of the respective predecessor corporation, that result did not actually occur as the reorganization was carried out. On each reorganization the successor corporation assumed and paid in full the indebtedness of the unsecured creditors, although such indebtedness was inferior to the indebtedness secured by the bond mortgage and on the second reorganization all of the holders of stock in the predecessor corporation received stock in the successor corporation, thus preserving a continuity of stock ownership and the adjustment of the bond indebtedness on each reorganization enhanced the value of the stockholders' equity.

The applicable statutory provisions are set forth in Note 5.⁵

The second reorganization in the instant case was a reorganization in the sense that term was defined in § 112(i) (1) of the Revenue Act of 1928 and the first reorganization in the instant case came within the provisions of § 202(b) of the Revenue Act of 1918.⁶

Under § 115(a) (2) a distribution by a corporation to its shareholders out of its earnings or profits of the taxable year in which the distribution is made is a dividend and taxable as such, even though the...