Walt Disney Inc. v. Comm'r of Internal Revenue, Docket No. 35695-87.

• Decision Date: 05 August 1991
• Docket Number: Docket No. 35695-87.
• Citation: 97 T.C. No. 13,97 T.C. 221
• Parties: WALT DISNEY INCORPORATED AS SUCCESSOR IN INTEREST TO RETLAW ENTERPRISES, INC. AND SUBSIDIARY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

97 T.C. 221

97 T.C. No. 13

WALT DISNEY INCORPORATED AS SUCCESSOR IN INTEREST TO RETLAW ENTERPRISES, INC. AND SUBSIDIARY, Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 35695-87.

United States Tax Court

Filed August 5, 1991.

Corporation P and the shareholders of corporation R entered into an agreement to enable P to acquire certain R assets by means of an exchange of stock, with P to receive all the stock of R. Conditions precedent to closing the transaction were that R would transfer to a wholly owned subsidiary all of the assets not wanted by P and that R would distribute the stock of this subsidiary to the R shareholders. On December 1, 1981, R transferred the assets unwanted by P to newly formed corporation FS and received in exchange the FS stock. Some of the transferred assets had unexpired useful lives for purposes of potential investment tax credit recapture. For the period ended January 28, 1982, R and FS filed a validly elected consolidated return. On January 28, 1982, R distributed its FS stock to the R shareholders. The R shareholders and P then consummated their exchange of stock.

HELD, the asset transfer from R to FS does not result in investment tax credit recapture. Sec. 1.1502-3(f)(2) and (3), Income Tax Regs. Held further, the step transaction doctrine does not apply to qualify or override sec. 1.1502-3(f)(2) and (3), Income Tax Regs. James G. Phillipp, Stephen L. Tolles, and Sally A. James, for the petitioner.

Richard H. Gannon, for the respondent.

OPINION

FEATHERSTON, JUDGE:

Respondent determined a deficiency in the amount of $453,197 in the Federal income tax of Retlaw Enterprises, Inc. (Retlaw), of which Walt Disney Incorporated (petitioner) is a successor in interest. The only issue remaining for decision is whether Retlaw is required to recapture investment tax credit for 1982 in an amount of $483,918 as a result of the transfer of certain assets to a newly formed subsidiary corporation.

All the facts are stipulated.

BACKGROUND

Petitioner's principal office was located in Burbank, California, at the time its petition was filed.

During the relevant period, Walt Disney Productions (Productions), later known as Walt Disney Company, was a California corporation engaged primarily in the production of motion pictures and television films, and in the operation of Disneyland in California and Walt Disney World in Florida. Its stock was publicly held.

Retlaw was a California corporation which, at all relevant times prior to December 1, 1981, had the following main businesses and assets (exclusive of cash and receivables):

(a) The commercial rights to the name “Walt Disney,” conveyed to Retlaw by Walter E. Disney prior to his death and licensed to Productions for its use in connection with its various business ventures;

(b) two “rides” or “attractions” at Disneyland, specifically the miniature railroad and the monorail system, both of which were owned and operated by Retlaw through its own employees on rights-of-way leased by Retlaw from Productions;

(c) two television broadcasting stations;

(d) a cattle ranch of approximately 14,000 acres; and

(e) various agricultural properties.

Retlaw's outstanding stock, which was all common stock, was owned during the taxable year in issue by the widow of Walter E. Disney, the Disneys' two daughters, and trusts for the benefit of two Disney grandchildren. Prior to January 28, 1982, Retlaw's taxable year was a 52-53 week year ending on the Saturday closest to the last day of March.

Sometime prior to April 9, 1980, Productions and Retlaw opened negotiations for Productions to acquire from Retlaw items (a) and (b), listed above, referred to herein as the “Disney assets.” Productions did not wish to acquire items (c), (d), and (e) above, or cash and receivables, all of which are referred to herein as the “non-Disney assets.” As a means of effecting the acquisition, Productions was willing to acquire the Disney assets directly or to acquire them indirectly by purchasing Retlaw's stock.

On June 29, 1981, after extensive negotiations between Retlaw and Productions, the Productions board of directors approved the Retlaw Acquisition Agreement (acquisition agreement). On July 8, 1981, Productions and the shareholders of Retlaw entered into the acquisition agreement. Under the terms of the acquisition agreement, Productions agreed, subject to certain conditions, to acquire all of the outstanding common stock of Retlaw in exchange for $46.2 million worth of Productions common stock. The exact number of Production shares was to be determined by reference to the average closing price of Productions stock on the New York Stock Exchange during a specified period immediately preceding the closing date of the transaction. The closing date was to be not later than 30 days after the Productions shareholders approved the acquisition agreement.

Among the conditions precedent specified in the acquisition agreement were the following:

(1) On or before the closing date, Retlaw would transfer to a wholly owned subsidiary all of the Retlaw liabilities and non- Disney assets, and would distribute the stock of the wholly owned subsidiary to the Retlaw shareholders;

(2) the acquisition agreement would be approved on or before the closing date by a vote of the Productions shareholders owning a majority of the Productions common shares voting on the matter (exclusive of the shareholders of Productions who were also shareholders of Retlaw, and certain related persons);

(3) there would be no court order in effect on the closing date restraining or enjoining the acquisition by Productions of the Retlaw common stock; and

(4) all of the representations and warranties of the Retlaw shareholders contained in the acquisition agreement would be true as of the closing date.

Productions could waive the conditions contained in the acquisition agreement, including those listed above.

On or about July 1, 1981, Retlaw and Productions through their respective attorneys requested a ruling from the Internal Revenue Service (IRS) concerning the income tax consequences of the proposed transactions. The request was approved on October 22, 1981, with the IRS concluding that: (1) The exchange of Retlaw assets for all the stock of a newly formed corporation, followed by the distribution of the stock to the Retlaw shareholders, would be a reorganization within the meaning of section 368(a)(1)(D); ¹ and (2) the subsequent exchange of all the Retlaw stock for Productions stock would be a reorganization within the meaning of section 368(a)(1)(B).

On December 1, 1981, Retlaw transferred to The 1333 Flower Street Co., Inc. (Flower Street), a newly created California corporation, all of the non-Disney assets in exchange for 4,500 shares of Flower Street's authorized but unissued common stock. Retlaw had previously claimed investment tax credits under section 38 on certain of these transferred non-Disney assets. Retlaw took no formal action, as evidenced by shareholder or board resolutions, contemplating the liquidation of Flower Street in the event the acquisition of Retlaw by Productions failed to occur.

On December 18, 1981, Productions commenced the solicitation of shareholder proxies for a meeting on January 28, 1982, which meeting had been scheduled earlier for the purpose, among others, of approving or rejecting the acquisition agreement. On January 28, 1982, the shareholders of Productions approved the acquisition of the Retlaw stock by an affirmative vote of 93 percent of the common shares voted.

On January 28, 1982, immediately following the meeting of its shareholders, Productions proceeded to acquire all of the outstanding stock of Retlaw on the terms set forth in the acquisition agreement. Productions transferred to the Retlaw shareholders $46.2 million worth of Productions common stock valued pursuant to the agreed formula. The Retlaw shareholders transferred to Productions all of the outstanding common stock of Retlaw.

On the same day as and immediately before Productions acquired all of the common stock of Retlaw, Retlaw distributed to its own shareholders, pro rata with respect to their stock in Retlaw, all of the common stock of Flower Street theretofore owned by Retlaw. Both Retlaw (currently known as Disney Inc.) ² and Flower Street (currently known as Retlaw Enterprises, Inc.) remained in existence as operating entities through the date of the Stipulation of Facts filed in this proceeding.

Prior to the closing of the acquisition, on January 25, 1982, certain Productions shareholders instituted a shareholders' derivative suit seeking a permanent injunction and alleging that the price of the Retlaw stock called for in the acquisition agreement was too high. As of the closing date, no temporary restraining order was in effect and the suit did not impede the closing. The suit was finally settled in October of 1983 under an agreement whereby the number of Productions shares transferred to the Retlaw shareholders on the closing date was adjusted downward by about 8 percent, or 70,000 shares.

For its short taxable year ended January 28, 1982, Retlaw, as the common parent of an affiliated group, elected to file a consolidated Federal income tax return with Flower Street. The consolidated return included the income and deductions of Retlaw for the period March 29, 1981, through January 28, 1982, and the income and deductions of Flower Street for the period December 1, 1981, through January 28, 1982. The parties have stipulated that Retlaw and Flower Street were entitled to file a consolidated return for the short taxable year ended January 28, 1982, and made a valid election to do so.

By reason of the acquisition of the Retlaw common stock by Productions, Retlaw on January 28, 1982, became a member of an affiliated group of which Productions was the common parent and which had previously elected to file its Federal income tax returns on a consolidated basis.

DISCU...