Appeal from the United States Tax Court.
This case comes to us on appeal from the United States Tax Court, which granted summary judgment in favor of the respondent Commissioner of Internal Revenue ("Commissioner") against the petitioner National Tea Co. and Consolidated Subsidiaries ("National Tea"). The issue raised is whether an acquiring corporation, which seeks to carry back net operating losses it incurred subsequent to a reorganization (stipulated by the parties to be a reorganization as defined by Section 368(a)(1)(F) of the Internal Revenue Code, i.e., an "F" reorganization) to income earned by the transferor corporation before the reorganization, must meet the loss-tracing requirement adopted by the Commissioner inRev. Rul. 75-561, 1975-2 C.B. 129, based on the Supreme Court's decision in Libson Shops, Inc. v. Koehler, 353 U.S. 382, 1 L. Ed. 2d 924, 77 S. Ct. 990 . For the reasons decision of the Tax Court that National Tea must follow this so-called Libson Shops loss-tracing rule. National Tea does not satisfy this rule, so that its claimed loss carryback must be denied.
Since the facts have been fully stipulated and are well defined by the Tax Court in its opinion, only a brief summary is required. Supermarkets was a Louisiana corporation that operated a chain of retail food stores in and around New Orleans. National Tea is an Illinois corporation, which along with its subsidiaries operates a chain of retail food stores in various areas of the United States. In 1954 National Tea acquired approximately 98% of the outstanding stock by December 26, 1974, National Tea owned 99.98% of the outstanding stock of Supermarkets. From 1954 until December 26, 1974, Supermarkets operated as part of National Tea's single integrated retail marketing operation of retail food stores.
On December 26, 1974, Supermarkets transferred all of its assets to National Tea, and Supermarkets' separate corporate existence ceased. This merger was accomplished under the applicable short-form Merger Statutes of Illinois and Louisiana. Supermarkets' other shareholders received cash in exchange for their aggregate 0.02% interest. For the taxable year ending December 28, 1974, National Tea and its affiliated subsidiaries incurred a substantial loss, which included a net operating loss of $3,304,858 subject to the carryover and carryback*fn1 provisions of Section 172. No part of this $3,304,858 net operating loss was attributable to the New Orleans regional organization, which had been operated by Supermarkets prior to December 26, 1974, and by National Tea thereafter.
National Tea attempted to carryback this net operating loss of $3,304,858 to Supermarkets' taxable year ending April 1, 1972, and thereby use this post-reorganization net operating loss to offset Supermarkets' pre-reorganization income. Such a carryback would result in an income tax refund totalling $1,586,332. National Tea's argument for being able to carry back this net operating loss is that the 1974 merger of Supermarkets into National Tea was an "F" reorganization, and that the general prohibition of Section 381(b)(3) against the carryback of post-reorganization losses incurred by the acquiring company (National Tea in the instant case) to a pre-reorganization year of the transferor corporation (Supermarkets in the instant case) does not apply. Furthermore, National Tea contends that any judicially created restrictions on loss carrybacks that existed under the 1939 Code were overruled when Congress adopted the 1954 Code, and therefore National Tea does not have to satisfy those restrictions, such as the Libson Shops loss-tracing rule of Libson Shops, inc. v. Koehler, 353 U.S. 382, 1 L. Ed. 2d 924, 77 S. Ct. 990, which are not set out in the later Code. The Internal Revenue Service concedes that the 1974 merger was an "F" reorganization, consistent with its position inRev. Rul. 75-561, 1975-2 C.B. 129. However, the Commissioner claims that National Tea must satisfy the loss-tracing rule first adopted by the Supreme Court in 1957 in Libson Shops, and subsequently adopted by the Service inRev. Rul. 75-561, 1975-2 C.B. 129. This loss-tracing rule limits the carryback of a post-reorganization net operating loss incurred by the acquiring corporation to a pre-reorganization year of the transferor corporation to those cases where the net operating loss was generated by "a separate business unit or division (of the acquiring corporation) formerly operate by the transferor corporation."Rev. Rul. 75-561, 1975-2 C.B. 129.
Thus the issue for us to decide is the validity of the Commissioner's applying the Libson Shops loss-tracing rule to an attempted carryback of a net operating loss incurred by the acquiring corporation after an "F" reorganization to income realized by the transferor corporation in a taxable year prior to the "F" reorganization.*fn2 To answer this difficult statutory question, it is necessary to review the tortuous history of the "F" reorganization concept so that the meaning and intent behind Congress' exception of "F" reorganizations from the general prohibition of carrybacks enacted in Section 381(b)(3) can be understood.
The "F" reorganization is one of many different types of reorganizations described in Section 368. If an acquisition can be classified as a reorganization (which involves meeting certain judicially created doctrines as well as several different statutory sections of Subchapter C of the Code), then as a general rule no gain is recognized. Significantly for the instant case, another result that flows from the classification of an asset acquisition as a reorganization is that under Sections 381-383, the tax attributes of the transferor corporation are carried over to the acquiring corporation. One such tax attribute is net operating losses, the concern of this case.
Unlike some of the other types of reorganizations in Section 368(a), which feature rather complex definitions, the definition of an "F" reorganization has always been comparatively and indeed deceptively simple: " a mere change in identity, form, or place of organization." Section 368(a)(1)(F). Two of the three clauses in this definition seem fairly clear. A "mere change in identity" refers to a change in a corporation's name, and a "mere change in . . . place of organization" refers to a decision to reincorporate in another state. However, the meaning of a "a mere change in . . . form" has proven to be more elusive.
There is a strong case to be made that "a mere change in . . . form" was meant to cover only the simplest types of corporate restructuring, such as the "cosmetic" types of changes described above, and was never intended to include a reorganization of two or more operating corporations. The "F" reorganization first appeared in the Revenue Act of 1921, which defined it as a "mere change in identity, form, or place of organization of a corporation " (emphasis supplied). Although the phrase "of a corporation" was deleted in the Revenue Act of 1924, the House Ways and Means Committee explained the deletion as "minor changes in phraseology," H. R. Rep. No. 179, 68th Cong., 1st Sess. 13, and there was no indication that Congress intended this change to have any significance. Estate of Stauffer v. Commissioner, 48 T.C. 277, 299 (1967), reversed, 403 F.2d 611 (9th Cir. 1968). For the next thirty years the definition remained unchanged, and the courts did little during this tie to delineate the boundaries of this definition; the case they faced dealt chiefly with simple restructuring of a single operating corporation. See McManus, Judicial Law-Making: The Liquidation of a Corporation Treated as an F Reorganization, 2 J. Corp. Tax'n 273, 285-286, 286 n.44 (1975), and cases collected therein. The definition remained unchanged in the 1954 Code and continued unchanged through the relevant time period for purposes of deciding the instant case. See supra note 2. The Tax Court has noted several times that, based on this legislative history, Congress never intended that an "F" reorganization should encompass the merger of multiple operating corporation. Estate of Stauffer, 48 T.C. at 299-302; Associated Machine, Inc. v. Commissioner, 48 T.C. 318, 328 (1967), reversed, 403 F.2d 622 (9th Cir. 1968); Romy Hammes, Inc. v. Commissioner, 68 T.C. 900, 906 n.8, 908 (1977). Numerous commentator shave carefully analyzed the history of the "F" reorganization and concluded that congress never intended that a reorganization involving multiple operating corporations could be classified as an "F" reorganization. See Metzer, An Effective Use of Plain English- The Evolution and Impact of Section 368(a)(1)(F), 32 Tax Lawyer 702, 704-708 (1979); Solomon, The Judicially Expanded "F" Reorganization and its Uncertain Operating Rules, 7 J. corp. Tax'n 24, 26 (1980); McManus, 2 J. Corp. Tax'n 273, 285-286; Comment, (F) Reorganization and Prosposed Alternate Routes for Post Reorganization Net Operating Loss Carrybacks, 66 Mich. L. Rev. 498, 509-510 (1968); Note, Section 368(a)(1)(F) and Loss Carrybacks in Corporate Reorganizations, 117 U. Pa. L. Rev. 764, 772 (1969). Until the mid-1960's, such an argument was entirely consistent with existing case law. See Note, 117 U. Pa. L. Rev. 764, 772. Indeed, until that time, the "F" reorganization was seldom used and not considered a significant type of reorganization. See McManus, 2 J. Corp. Tax'n 273; Note, 117 U. Pa. L. Rev. 764, 772; Bittker & Eustice, FEDERAL INCOME TAXATION OF CORPORATION AND SHAREHOLDERS P 14.18 (4th Ed. 1979) (hereinafter referred to as "Bittker & Eustice").
In the late 1960's to everyone's surprise, several cases judicially expanded the definition of an "F" reorganization to include a merger of multiple operating corporations in certain circumstances. The judicial expansion began, ironically enough, with a decision in favor of the Commissioner. The problem facing the Commissioner was the liquidation-reincorporation scheme, whereby A, a group of shareholders who own corporation X, are able to withdraw a substantial amount of X's appreciated corporate assets at capital gains rates while keeping the assets in corporate solution (such as reincorporating the assets in corporation Y, also owned by A). There were several ways to achieve this result, see Metzer, 32 Tax Lawyer 702, 716-717, but one way was for A to sell their X stock to an unrelated third party B, have B sell the assets of X to Y (another existing corporation also owned by A), have B liquidate X, and let B take a reasonable profit for his services. For this scheme to succeed, A must avoid having the transaction reclassified as a reorganization. This precise version of the liquidation-reincorporation scheme was litigated in the case of Davant v. Commissioner, 366 F.2d 874 (5th Cir. 1966), certiorari denied, 386 U.S. 1022, 87 S. Ct. 1370, 18 L. Ed. 2d 460. The Commissioner decided to attack this scheme by arguing that since Y was merely the alter ego of X, this was nothing more than "a change in corporate vehicles but not a change in substance," Davant, 366 F.2d at 884, and hence an "F" reorganization. Although the Commissioner had raised this argument in previous cases, see Metzer, 32 Tax Lawyer 702, 720-722, in Davant the Commissioner won for the first time. See Note, 117 U. Pa. L. Rev. 764, 772-773 (describes Davant and the arguments raised in the case).
Davant, however, turned out to be a Pyrrhic victory. Because the general rule of Section 381(b)(3)-that an acquiring corporation cannot carryback post-reorganization net operating losses to income of the transferor corporation-has an explicit exception for "F" reorganizations, and Davant greatly expanded the definition of an "F" reorganization to include certain mergers of multiple operating corporation, the door was now open for an acquiring corporation to carryback net operating losses to a transferor corporation in many more transactions than had been previously though possible. See Note, 117 U. Pa. L. Rev. 764, 776. It is not clear whether the Commissioner or the Fifth Circuit realized this significant result of the Davant opinion, but taxpayers wasted no time in taking advantage of it. The issue arose in two types of transactions: the liquidation of a wholly-owned subsidiary into its parent (such as the instant case), and the merger of two corporations owned by the same shareholders.*fn3 In both types of transactions, courts held that so long as there is (1) an identity of the shareholders and their propriety interests in both the transferor corporation and the acquiring corporation (in the context of a liquidation and the acquiring corporation (in the context of a liquidation of a wholly-owned subsidiary into the parent corporation, this was satisfied if the parent corporation's shareholders and their proprietary interests did not change); and (2) the business enterprise of the transferor corporation continued unimpaired, these transactions were both "F" reorganizations, and therefore the acquiring corporation could carryback post-reorganization net operating losses against pre-reorganization income of the transferor corporation under Section 381(b)(3). See, e.g., Performance Systems, Inc. v. United States, 382 F. Supp. 525 (M.D. Tenn. 1973), affirmed per curiam, 501 F.2d 1338 (6th Cir. 1974) (merger of subsidiary into parent); Movielab, Inc. v. United States, 204 Ct. Cl. 6, 494 F.2d 693 (Ct. Cl. 1974) (merger of subsidiary into parent); Home Construction Corp. v. United States, 439 F.2d 1165 (5th Cir. 1971) (merger of corporations owned by same shareholders); Estate of Stauffer c. Commissioner, 403 F.2d 611 (9th Cir. 1968) (merger of corporations owned by same shareholders); Associated Machine, Inc. v. Commissioner, 403 F.2d 622 (9th Cir. 1968) (merger of corporations owned by same shareholders); Eastern Color Printing Co. v. Commissioner, 63 T.C. 27 (1974) (merger of subsidiary into parent). The Commissioner initially ...