Appeals from the United States District Court for the Northern District of Indiana, Fort Wayne Division Nos. 73 F 104 and 73 F 105 - Jesse E. Eschbach, Judge.
Swygert and Bauer, Circuit Judges, and William J. Jameson,*fn* Senior District Judge.
JAMESON, Senior District Judge:
This appeal involves the tax consequences of a merger of a parent corporation into its subsidiary, brought about by the subsidiary's purchase of the parent's stock with insurance proceeds received from the involuntary conversion of the subsidiary's assets through fire. The taxpayer, Broadview Lumber Company, brought two suits to recover federal income taxes - one (No. 73 F 104) to recover taxes paid for its taxable years 1967, 1968 and 1969 in the amount of $51,900.06, and the other (No. 73 F 105) to recover taxes paid in its capacity as successor in interest by statutory merger to Allen County Lumber Company for Allen's taxable year 1968 in the amount of $32,503.19. The issues presented center on the provisions of sections 1033 (involuntary conversions), 304 (redemption of stock through related corporations), and 334 (basis of property received in liquidation) of the Internal Revenue Code of 1954.
The facts were stipulated and the two cases consolidated for trial. The district court entered summary judgment for the Government in 73 F 105, holding that Allen received a constructive dividend upon Broadview's purchase of its outstanding shares of stock, and that Broadview, as Allen's successor, was liable for the tax. Summary judgment was entered for Broadview in 73 F 104, the court holding that section 1033 prohibited recognition of gain to Broadview upon receipt of the fire loss insurance proceeds. The court held further, however, that the assets acquired from Allen should have been recorded by Broadview at a cost basis (with adjustments) instead of a carry-over basis.
Broadview appeals from the judgment in 73 F 105 and that portion of the judgment in 73 F 104 holding that it was not entitled to record the assets of Allen received under the merger on a carry-over basis. The Government cross-appeals in 73 F 104 insofar as any refund was allowed.
We conclude that Broadview should prevail on all issues and accordingly reverse the judgment of the district court in 73 F 105 and affirm, as modified herein, the judgment in 73 F 104.
Broadview Lumber Company and Allen County Lumber Company were competitors engaged in the business of selling lumber products in Allen County, Indiana and the surrounding area. On April 20, 1968, substantially all of Broadview's assets, having an adjusted basis of $230,943.16, were destroyed by fire. Broadview received insurance proceeds in the amount of $413,210.28, thus realizing a gain of $182,267.11 on the involuntary conversion. At the time of the fire, 634 of Broadview's 1,000 shares of common stock were owned by Allen. Of Allen's 780 common shares, 365 were owned by the Fisher family and 415 by the Johnson family.*fn1
Desiring to avoid recognition of the gain arising from the involuntary conversion, Broadview sought to reinvest the insurance proceeds in property similar to that destroyed by the fire and to that end decided to attempt to gain control of Allen. Pursuant to this plan Allen redeemed the 365 shares of its stock owned by the Fisher family for $1,000 per share, leaving the 415 shares owned by the Johnson family outstanding. On June 8, 1968, Broadview's directors authorized payment of $415,000 to the Johnson family for its stock in Allen. Payment for this stock was made on June 11. On June 12, the directors of Broadview approved the merger of Allen into Broadview. All the assets and liabilities of Allen were transferred to Broadview effective June 15, 1968. The effect of these transactions was that Broadview, a subsidiary of Allen, became Allen's parent corporation for a short period of time and then the surviving corporation following the merger.
Following the merger, Broadview recorded the assets received from Allen as having the same basis which they had in Allen's hands, without reduction for the gain realized as a result of the involuntary conversion. Broadview did not report the $182,267.12 gain on its federal income tax return for its fiscal year ending November 30, 1968, but treated the gain as subject to nonrecognition under section 1033. After audit, the District Director of Internal Revenue held that the gain must be recognized. The Director also held that the $415,000 paid by Broadview to Allen's shareholders must be treated as a constructive dividend from Broadview to Allen under section 304(a)(2). Broadview paid the resulting deficiency assessments*fn2 and filed administrative claims for refund. Subsequently these refund suits were filed pursuant to 28 U.S.C. § 1346(a)(1).
1. Did Allen receive a taxable dividend under section 304(a)(2) upon the purchase by Broadview, Allen's subsidiary, of Allen's stock?
2. Was Broadview entitled to treat its involuntary gain as nonrecognizable under section 1033?
3. Was the proper basis for the assets received by Broadview from Allen the acquisition cost rather than the carry-over basis?
I. The Constructive Dividend Issue (No. 73 F 105)
The district court found that under sections 304(a)(2) and (b)(2)(B)*fn3 "Allen County received a constructive dividend in the amount of $415,000 upon the purchase of its shares by Broadview from the Johnsons". The court relied upon the holding of the Tax Court in Union Bankers Insurance Co., 64 T.C. 807 (1975). The Tax Court there held that under these statutory provisions if a subsidiary corporation purchases shares of its parent corporation from one of the parent's shareholders, the parent corporation receives a taxable constructive dividend.*fn4
Subsequent to the decision of the district court, however, the Tax Court, with the full court sitting,*fn5 decided Helen M. Webb, 67 T.C. No. 24 (Nov. 24, 1976). The Tax Court there held that a parent corporation did not realize a constructive dividend under the provisions of section 304 upon the purchase of its stock by a subsidiary. The court expressly stated that it would "no longer follow the reasoning of Union Bankers or Broadview Lumber Co. v. United States ".*fn6 Webb was followed in Virginia Materials Corp., decided December 2, 1976, 67 T.C. No. 29, under a factual situation very similar to the instant case.
The Government argues that " Union Bankers was correctly decided, and that the Tax Court erred in its Webb and Virginia Materials decisions". Both parties here and the Tax Court in its decisions rely upon the language and legislative history of Section 304. As the Tax Court noted in Virginia Materials, the issue "is a narrow one of statutory construction", and "resolution of the issue turns on whether the application of section 304(a)(2) as supplemented by section 304(b)(2)(B) is limited to determining tax consequences to the selling shareholder, or whether the cited sections, when applicable, also construct a taxable intercorporate distribution from the purchasing subsidiary to its parent". (Op. at 6-7).
In 1950, Congress added section 115(g)(2), the predecessor of section 304, to the Internal Revenue Code of 1939 in response to a loophole created by judicial interpretation of section 115(g) of the 1939 Code. Section 115(g) imposed a tax upon corporate stock redemptions which were essentially equivalent to the distribution of a taxable dividend. In Rodman Wanamaker Trust, 11 T.C. 365 (1948), aff'd sub nom. 178 F.2d 10 (3 Cir. 1949), the Tax Court held that 115(g) was applicable only where a corporation cancels or redeems its own stock; it was not applicable where a subsidiary corporation purchased the stock of its parent corporation from the parent corporation's shareholders. Thus by indirect redemption corporations were able to circumvent the tax imposed by section 115(g) and still achieve essentially the same results as by direct redemption.
Congress responded by providing in section 115(g)(2) for treatment of the amount paid for the acquisition of the parent, issuing corporation stock as:
The substance of section 115(g)(2) was incorporated into the 1954 Code as section 304(a)(2), which was supplemented by section 304(b)(2)(B). (See note 3) In a careful analysis of the language of that section and its legislative history the Tax Court concluded in Webb that the section "merely creates a series of fictions which are to be applied in order to close the loophole revealed by the Wanamaker opinion. Under that section the payment of the selling price is 'treated' as a 'distribution in redemption' of the parent corporation's stock. The stock is not actually redeemed but becomes an asset of the subsidiary corporation. . . . These fictions do not change the reality that the parent's stock is not actually redeemed." (Op. at 29-31). We agree.
Congress chose to treat the acquisition as a redemption by the parent corporation, and as such the transaction would be measured by the "essentially equivalent to a dividend" standards of 115(g)(1) to determine the tax consequences. The extent of any dividend was based upon treating the amount paid as if it passed first to the issuing corporation and then to the shareholder. Nothing in the statutory language describing this fictionalized treatment of the amount paid gives any indication that Congress intended the fictional distribution from the subsidiary to the parent also to be a taxable dividend to the parent.
That Congress intended this fictional redemption treatment solely for the specific and limited purpose of closing the loophole created by Wanamaker is apparent from the Congressional reports which accompanied the addition of 115(g)(2) to the Code. The House Report stated that the amendments would add paragraph (2) to section 115(g) "to require the application of section 115(g)(1)" to such indirect redemptions; that this special treatment of indirect redemptions was "for the purposes of section 115(g)(1)". The amount paid for the stock was not actually distributed to the parent corporation, but only "as though it had been". H.R. Rep. No. 2319, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 380, 440; accord, S.Rep. No. 2375, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 483, 541-42. Because section 115(g)(1) was concerned only with taxation of the shareholder and not taxation of the parent corporation, the effect of the fictional ...