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Commissioner of Internal Revenue v. Western Power Corporation.


February 7, 1938


Appeal from the Board of Tax Appeals.

Author: Hand

The North American Company, a New Jersey corporation, owned 99.8 per cent of the common stock of the taxpayer, but was not affiliated with it because of outstanding voting preferred stock of the latter. The North American Company was a large holding corporation owning stocks of public utility companies in various states of the union.

The taxpayer is a New York corporation whose business is investment in capital stock of public utility corporations. It owned 4904 12/40 shares of common stock of North American Company and also owned shares of stock in its own subsidiary corporations as hereinafter set forth. These three corporations operated in the State of California in contiguous territory. Their business was to furnish electric light and power and in some cases gas and steam. Prior to the transactions about to be described, the classes of stock, all having a par value of $100 per share, and the number of shares owned by the taxpayer were as follows:

Great Western Power Company of California


Authorized Outstanding owned by

shares shares taxpayer

Preferred stock 150,000 129,278

Preferred stock Series A 150,000 48,965

Common stock 300,000 300,000 300,000

San Joaquin Light & Power Corporation

Prior preferred stock 250,000 118,426 897

Prior preferred stock Series A 500,000 26,276 1,462

Preferred stock Series A 185,000 64,684 45,159

Preferred stock Series B 65,000 316

Common stock 500,000 130,000 128,867

Midland Counties Public Service Corporation

Preferred stock 10,000 5 5

Common stock 20,000 10,000 10,00

All of the stock of each of the above companies had full voting powers, and the percentage of voting stock of each company owned by the taxpayer was as follows:

Per cent

Great Western Power Company of California 62.73

San Joaquin Light & Power Corporation 51.92

Midland Counties Public Service Corporation 100.00

The taxpayer acquired its stock in Great Western Power Company of California in 1918 and in San Joaquin and Midland Corporations in 1925.

The Pacific Gas & Electric Company (hereinafter called Pacific) was a California corporation engaged in a public utility business in California serving territory indentical with or contiguous to the three operating corporations last mentioned.

On March 29, 1930, the North American Company entered into an agreement with the Pacific which provided that the North American should cause the taxpayer to assign the stock wich it held in Great Western Power Company of California, San Joaquin Light & power Corporation, and Midland Counties Public Service Corporation to Pacific, and to cancel the indeptedness of these three subsidiaries to the taxpayer in the amount of $19,180,776.76, in consideration for which Pacific should sell and deliver to the taxpayer 1,825,000 shares of its own common stock of the par value of $25 per share. Under this agreement the taxpayer was to transfer to Pacific substantially all its property except the 4904 12/40 shares of stock of the North American Company. The agreement was duly authorized by the proper authorities and was carried out as provided. Thereafter, on June 12, 1930, the taxpayer became the owner of 32 per cent. of the common stock of Pacific and 19.17 per cent. of its voting of all classes and taxpayer had no other property. The 4904 12/40 shares of North American Company were disposed of by the taxpayer during May, 1930, in exchange for common stock of Cleveland Electric Illuminating Company, which latter stock was sold by taxpayer on June 10, 1930, and the proceeds paid over to the North American Company in reduction of the taxpayer's debt to it.

At the time of receipt of the 1,825,000 shares of Pacific common stock, neither the taxpayer nor the North American Company owned any of the shares of Pacific's capital stock. After June 12, 1930, Pacific proceeded to acquire the minority stock interests outstanding in Great Western Power Company, so that by April, 1934, it held practically all the stock of all classes of Great Western and 99.12 per cent. of the common stock of San Joaquin and greatly increased majority of the aggregate shares issued.

Prior to June 12, 1930, Great Western, San Joaquin, and Midland were the only companies in California controlled by the taxpayer or the North American. After that date neither the taxpayer, nor its stockholders, nor both, controlled directly or indirectly Pacific or any companies operating west of the Rocky Mountains other than through the stock ownership in Pacific acquired by the exchange occuring on June 12.

Under the arrangement of June 12, 1930, that we have described, the Board said in its opinion:

"* * * many economies were effected by eliminating duplication of labor, personnel, offices, warehouses, equipment, materials and supplies, and other expenses. Connections were established between the electric and steam systems of Pacific and Great Western, and between the electric systems of Pacific and San Joaquin, permitting large interchanges of electric energy and steam, abandonment of certain plants, readjustment of others, and the shutting down of still other plants and substations for long periods of time, all resulting in better and more efficient use of the production, transmission, and distribution facilities of the systems and their operartions as one combined business and system. It was estimated by Pacific that by October 1, 1930, savings in annual operating and construction expenses amounted to $1,334,000."

As a result of the transfer of the stock to the Pacific the Commissioner held that the taxpayer had realized a profit of $68,969,197.89 and that thereby there was a deficiency of $8,295,605.39 in its income taxes for the year 1930. The Board of Tax Appeals decided that the arrangement carried out under the agreement between the taxpayer and the Pacific involved a reorganization and that no gain should be recognized.

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

AUGUSTUS N. HAND, Circuit Judge (after stating the facts as above).

This is a petition by the Commissioner of Internal Revenue to review a determination of the Board of Tax Appeals holding that there was no deficiency in the income taxes of the respondent Western Power Corporation for the year 1930. The Commissioner claims a deficiency in the amount of $8,295,605.39 and interest.We hold that the decision of the Board of Tax Appeals was right and should be affirmed.

The principal question involved is whether the transfer by the taxpayer of substantially all of its assets, consisting of more than a majority of the voting and outstanding stock of each of its three subsidiary public utility companies, to Pacific Gas & Electric Company in exchange for 1,825,000 shares of the common stock of the latter, constituted a "reorganization" or nontaxable exchange within the meaning of section 112 of the Revenue Act of 1928, 45 Stat. 816, 26 U.S.C.A. § 112 and note.

The provisions of the statute, section 112(i)(1), 26 U.S.C.A. § 112 note, defining the meaning of "reorganization" are as follows:

" § 112. * * *

"(i) Definition of Reorganization. As used in this section and sections 113 and 115 -

"(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, or substantially all the properties of another corporation), or (B) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred, or (C) a recapitalization, or (D) a mere change in identity, form, or place of organization, however effected."

Counsel for the Commissioner argue that the transfer to the Pacific, an operating company, by the taxpayer, a holding company, without an acquisition by the latter of a controlling interest in Pacific, did not constitute a reorganization under section 112. But, in view of the construction placed upon that section by the Supreme Court, we think it evident that the exchange of securities between the taxpayer and the Pacific did amount to a "reorganization." Pacific acquired a majority of the voting stock of the three subsidiary companies of the taxpayer, and thus became possessed of substantially all the properties of the latter which consisted almost entirely of the stocks of the subsidiaries. The taxpayer acquired a substantial interest in the purchaser.

In Helvering v. Minnesota Tea Co., 296 U.S. 378, 383, 384, 386, 56 S. Ct. 269, 272, 80 L. Ed. 284, the Commissioner contended that, because clause (A) of section 112(i)(1) defines a "reorganization" as a "merger or consolidation," and then proceeds to amplify the strict meaning of those words, the clause should be so limited as to include only transactions nearly akin to technical mergers or consolidations. The Commissioner also contended that under clause (B), where there is a transfer by a corporation of all or a part of its assets to another corporation, the transferor must obtain control of the transferee in order to effect a reorganization, and argued that this requirement of control of the transferee furnishes a further reason for restricting the meaning of clause (A) so as to prevent overlapping. But in Helvering v. Minnesota Tea Co., supra, the taxpayer had transferred substantially all of its assets to Grand Union Company in return for cash and voting trust certificates in 1,800 shares of common stock of Grand Union which amounted to only 7 1/2 per cent. of the outstanding common stock of the purchaser. Justice McReynolds, in discussing clauses (A) and (B), said:

"We find nothing in the history or words employed which indicates an intention to modify the evident meaning of (A) by what appears in (B). Both can have effect, and if one does somewhat overlap the other the taxpayer should not be denied, for that reason, what one paragraph clearly grants him.* * *

"The transaction * * * was no sale, but partook of the nature of a reorganization, in that the seller acquired a definite and substantial interest in the purchaser."

This was said in spite of the fact that the relationship of the taxpayer to the assets conveyed had been substantially changed and the transferor corporation, as in the present case, was not dissolved under the reorganization plan. See, also, Nelson Co. v. Helvering, 296 U.S. 374, 56 S. Ct. 273, 80 L. Ed. 281; G. & K. Manufacturing Co. v. Helvering, 296 U.S. 389, 56 S. Ct. 276, 80 L. Ed. 291. When construing clause (A) of section 934(h)(1) of the Revenue Act of 1926 in Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462, 469, 470, 53 S. Ct. 257, 260, 77 L. Ed. 428, the court said: "The words within the parenthesis may not be disregarded. They expand the meaning of 'merger' or 'consolidation' 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."

The decision in Helvering v. Watts, 296 U.S. 387, 56 S. Ct. 275, 80 L. Ed. 289, affirming Watts v. Commissioner, 2 Cir., 75 F.2d 981, is also in point. There the taxpayer, when owning all the stock of Ferro Alloys Corporation, transferred it to Vanadium Corporation in exchange for stock of the latter and for certain bonds of Ferro Alloys guaranteed by Vanadium. The transaction was held a reorganization in which no gain should be recognized.

Not only did the taxpayer transfer substantially all its properties to Pacific in exchange for stock of the latter in pursuance of a plan of reorganization, but it also exchanged a majority of the voting stock of its three subsidiaries, parties to the reorganization, for such Pacific stock. The transaction, therefore, falls not only within the second alternative of the parenthesis contained in clause (A) supra, which we have already discussed, but within the first alternative because it involves: "The acquisition by one corporation of at least a majority of the voting stock * * * of another corporation."

The very arguments employed by the Commissioner before us were made in Helvering v. Minnesota Tea Co. and Helvering v. Watts without avail, and everything presented on his behalf on the present appeal has been so completely answered in the convincing brief and argument of the learned counsel for the taxpayer that we can feel no doubt about the correctness of the Board's decision.

We think counsel were right in their contention that: " * * * there is no escape from the conclusion that the Supreme Court has definitely settled the following proposition: There is a reorganization within the statute when (a) a corporation transfers substantially all of its assets to another corporation, and (b) receives therefor securities of the buyer which give it a definite interest in the buyer, and (c) those securities represent a substantial and material part of the value of the thing transferred." (Respondent's brief, p. 21.)

The Commissioner makes the further contention that he properly included $286,152.83 in the taxpayer's income and that under any circumstances there should be a redetermination of the latter's income taxes so as to assess a tax upon the foregoing item. The contention is unwarranted. The item represents interest upon the indebtedness to the taxpayer of the three subsidiaries between January 31, 1930, and May 1, 1930. The taxpayer was under an agreement with Pacific to cancel such indebtedness as of January 31, 1930. Accordingly, no interest for that period was due. Although the interest between the dates was accrued on the books of the taxpayer, it never was received by the latter, was accrued by mistake, and was canceled upon the demand of Pacific who allowed the taxpayer only interest between May 1 and June 12 - interest for that period being allowed because the closing date set at May 1 was adjourned to June 12 at Pacific's request. These facts were found by the Board, whose findings are binding upon us.

Order affirmed.


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