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Watts v. Commissioner of Internal Revenue

March 4, 1935

WATTS
v.
COMMISSIONER OF INTERNAL REVENUE; SICARD V. SAME; SLOANE V. SAME



Appeal from the Board of Tax Appeals.

Author: Chase

Before MANTON, AUGUSTUS N. HAND, and CHASE, Circuit Judges.

CHASE, Circuit Judge.

As the petitions all raise the same questions and were argued together, one opinion will be sufficient to dispose of them.

In December, 1924, the three petitioners, owning all of the stock of United States Ferro Alloys Corporation, a corporation to be hereafter designated merely as Alloys, exchanged all of their stock for stock in the Vanadium Corporation of America, a corporation which will herein be called Vanadium, and for mortgage bonds of Alloys which were guaranteed both as to the payment of principal and of interest by Vanadium. The contract was made in behalf of all of the petitioners by one of them and provided that an agreed number of Vanadium shares should be placed in escrow until January 1, 1926, from which there should be transferred to each of the petitioners such an amount of the stock, whose value for the purposes of the exchange was agreed to be $30 per share, as should be determined on the basis of the demonstrated earning power of Alloys in 1925. The contract was fully performed, and, when performed, the petitioners had, in place of all the stock of Alloys, 32.103 shares of Vanadium and bonds of Alloys to the amount of $1,161,194.50. Though the contract also included payments by Vanadium in cash to creditors of Alloys, the parties stipulated before the Board that the petitioners thereby received no taxable income. The business of Alloys continued to be conducted by that corporation until it was dissolved in 1928.

The position the respondent takes is that the petitioners sold their stock in Alloys and are taxable upon gains then realized as by a sale of stock at a profit. The petitioners contend that the transaction was tax free under section 203 of the Revenue Act of 1924 (26 USCA § 934), because they received only stock and bonds of corporations which were parties to a reorganization within the meaning of that statute.

The controlling facts may be stated in one sentence. The petitioners exchanged all of the stock of Alloys solely for stock in Vanadium and bonds of Alloys.

Section 203 (b) (2) of the Revenue Act of 1924 (26 USCA § 934 (b) (2), provided that: "No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization."

And section 203 (h) of the same statute provided, so far as here applicable, that: "(1) The term "reorganization" means (A) a merger or consolidation (including the acquisition by one corporation of at least a majority of the voting stock and at least a majority of the total number of shares of all other classes of stock of another corporation * * *)" 26 USCA § 934 (h) (1) (A).

Article 1574 of T.R. 65, in so far as pertinent to the present problem, provided that under the law above noted "* * * no gain or loss shall be recognized to the shareholders from the exchange of stock made in connection with the reorganization. * * * If two or more corporations reorganize, for example, by either * * * (3) the sale of the stock of B to A, or * * * (6) the acquisition by A of a majority of the total number of shares of all other classes of stock of B. * * *"

Since the transaction here involved is one that verbally falls within the concept of "reorganization" as shown by the regulation -- as all of the stock of Alloys went to Vanadium, either subdivision (3) or (6) covers the transaction -- the real issue is simply whether the regulation has unlawfully broadened the statutory definition of "reorganization." The plan of reorganization was the contract made and performed.

In the above statute it will be seen that reorganization was defined to be a merger or consolidation, with those terms somewhat expanded by matter in parenthesis "so as to include some things which partake of the nature of a merger or consolidation but are beyond the ordinary and commonly accepted meaning of those words -- so as to embrace circumstances difficult to delimit but which in strictness cannot be designated as either merger or consolidation." Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462, 470, 53 S. Ct. 257, 260, 77 L. Ed. 428. In Cortland Specialty Co. v. Commissioner, 60 F.2d 937, we had before us the taxable effect under the similar section 203 (h) (1) of the Revenue Act of 1926, 26 USCA § 934 (h) (1) of a sale of the assets of a corporation for cash and short-term notes, and held that the gain from the transaction was not tax free. In that connection we discussed merger and consolidation generally in their relation to a reorganization within the meaning of the statute, but the facts there did not present the issue now before us. And in C. H. Mead Coal Co. v. Commissioner (C.C.A.) 72 F.2d 22, while the precise question here was not involved, the necessity for giving a liberal scope to the words "merger" and "consolidation" as used in the statute, which, as already noticed, was in respects now essential like the statute controlling here, was recognized.

We think the legislative history of the statute requires its interpretation in a way which shows that the Board in this instance was in error in sustaining the deficiencies. It was divided in opinion, with the majority taking the view that there was no "reorganization" while there was no dissolution of Alloys.

In the Revenue Act of 1918, Congress for the first time dealt with the effect of reorganization upon taxation, and provided in section 202 (b), 40 Stat. 1060 that "* * * when in connection with the reorganization, merger, or consolidation of a corporation a person receives in place of stock or securities owned by him new stock or securities of no greater ...


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