The opinion of the court was delivered by: LEVET
Both plaintiff and defendant have moved for summary judgment in this action, which is a suit brought against the United States of America pursuant to United States Code, Title 28, Section 1346 for the refund of federal income taxes in the amount of $ 3,639,297.27, with interest, representing an alleged overpayment of plaintiff's consolidated corporate income tax for the calendar (taxable) year 1954.
Plaintiff's claims are two-fold:
1. The first is based upon an alleged erroneous disallowance by the Commissioner of Internal Revenue of credits against plaintiff's federal income tax under the provisions of Section 902 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 902, covering taxes paid to foreign countries.
2. The second is predicated upon an alleged erroneous reduction by the Commissioner of the basis of certain stock sold by an affiliated corporation under the provisions of Section 1502 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 1502, authorizing the Secretary or his delegate to prescribe such regulations as are deemed necessary to determine the tax liability of an affiliated group of corporations.
The material and relevant facts affecting both claims have been stipulated (see stipulation dated May 17, 1961). These facts insofar as they pertain to the first claim of plaintiff may be summarized as follows:
1. Plaintiff, Associated Telephone and Telegraph Company (hereinafter designated as 'Associated'), is a Delaware corporation with its principal place of business at 730 Third Avenue, New York, N.Y.
2. Automatic Electric Company (hereinafter designated as 'Automatic') is a wholly-owned subsidiary of Associated, organized under the laws of the State of Delaware.
3. Filcrest Company, Limited (hereinafter designated as 'Filcrest') for all relevant periods was a corporation duly organized and validly existing under the laws of the Dominion of Canada, being a wholly-owned subsidiary of Automatic.
4. Pan-American Telephone and Telegraph Company (hereinafter designated as 'Panco'), another corporation included in the affiliated group of plaintiff Associated, was a wholly-owned subsidiary of Automatic and for all relevant periods a duly organized and existing corporation under the laws of the State of Delaware.
5. On November 11, 1954 and November 15, 1954, the directors and stockholders of Filcrest, at meetings held in Chicago, Illinois, adopted resolutions providing for the liquidation of Filcrest; on November 25, 1954, the Supreme Court of Ontario, Canada, authorized the liquidation of Filcrest. Insofar as it relates to the instant action, the 'winding up' of a Canadian corporation is the same as a liquidation of an American corporation.
6. On December 15, 1954, the Filcrest liquidator, appointed by the Supreme Court of Ontario, Canada, distributed assets to Automatic, conceded by the parties hereto to have an aggregate fair market value of $ 9,574,386.10. Of this sum, $ 283,396.13 was paid directly to the Director of the Department of Internal Revenue, Taxation Division, of the Dominion of Canada by the liquidator in satisfaction of the 5% Dividend withholding tax imposed by Article XI.2 of the Income Tax Convention between the United States and Canada and the Canadian Income Tax Act, said tax authorities having previously determined that the amount of Filcrest's undistributed earnings and profits for Canadian tax purposes was $ 5,667,922.60 ($ 5,485,486.30 Canadian). The gain thus realized by Automatic on the liquidating distribution from Filcrest was reported as a long-term capital gain on plaintiff's 1954 consolidated return hereinafter mentioned.
7. Commencing with the taxable (calendar) year 1952, and for the taxable years 1953 and 1954, plaintiff filed consolidated federal income tax returns for itself and its subsidiary corporations (Automatic, Filcrest and Panco) -- the 'affiliated group.' On or about September 15, 1955, plaintiff duly filed with the Delaware District Director of Internal Revenue (the 'District Director') a consolidated federal income tax return (the '1954 consolidated return') for the affiliated group on Treasury Department Form 1120 for the calendar year 1954 under the provisions of Sections 1501 and 6012(a) of the Internal Revenue Code of 1954, as amended (the '1954 Code') 26 U.S.C.A. §§ 1501, 6012(a). The 1954 consolidated return disclosed consolidated taxable income in the amount of $ 14,969,808.42 and a consolidated income tax liability in the amount of $ 5,189,174.48, which latter amount was paid to the District Director within the time prescribed by law.
8. On December 15, 1954, at the time of Filcrest's liquidating dividend to Automatic, Filcrest, for federal income tax purposes, had accumulated earnings and profits after February 28, 1913 from Canadian sources in the amount of $ 6,322,008.64. With respect to such accumulated earnings and profits, Filcrest had paid to the Dominion of Canada and the Provinces of Quebec and Ontario income and /or excess profits taxes in the aggregate amount of $ 2,387,564.86.
9. The liquidating distribution referred to above in paragraph 6 was treated (by plaintiff) on the 1954 consolidated return, to the extent of Filcrest's accumulated earnings and profits, as a 'dividend' within the meaning of Section 902(a) of the 1954 Code; and, accordingly, pursuant to the provisions of Sections 901, 902 and 904 of the 1954 Code. 26 U.S.C.A. §§ 901, 902, 904 (as interpreted by plaintiff), plaintiff claimed a foreign tax credit for Canadian taxes in the amount of $ 2,387,564.86 (exclusive of the credit claimed under Section 901 for the amount of $ 283,396.13, the amount of the 5% Canadian tax withheld from the liquidating distribution).
10. The Commissioner of Internal Revenue of the United States of America (the 'Commissioner') in determining the amount of the deficiency with respect to the 1954 consolidated return, however, through his agents and deputies, disallowed the above-mentioned $ 2,387,564.86 of the foreign tax credit claimed by plaintiff on the ground that liquidating distributions resulted in capital gain or loss for tax purposes and are not to be considered as 'dividends' for purposes of Section 902(a) of the 1954 Code, the effect of which was to increase the amount of the consolidated federal income tax for the year 1954 by the sum of $ 2,387,564.86.
11. The plaintiff, after receipt of the '30-day letter' asserting other deficiencies (referred to in the Second Claim of plaintiff herein), paid the total asserted deficiency and interest and filed a claim for refund, which was disallowed, all as set forth in the stipulation above referred to.
The question presented to this court is, whether Automatic, a wholly-owned subsidiary of plaintiff, included in plaintiff's consolidated return for the year 1954, is entitled to a foreign tax credit for that year for income and/or excess profits taxes paid to the Dominion of Canada and the Provinces of Quebec and Ontario by Filcrest, with respect to Filcrest's accumulated earnings and profits since February 28, 1913, which were received by Automatic in the form of a liquidating distribution during the year 1954.
The relevant portions of the pertinent sections of the Internal Revenue Code of 1954 are as follows:
'301. Distributions of property
'(a) In General. -- Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).
'(b) Amount distributed. --
'(1) General rule. -- For purposes of this section, the amount of any distribution shall be --
'(A) Noncorporate distributees. -- If the shareholder is not a corporation, the amount of money received, plus the fair market value of the other property received.
'(B) Corporate distributees. -- If the shareholder is a corporation, the amount of money received, plus whichever of the following is the lesser:
'(i) the fair market value of the other property received; or
'(ii) the adjusted basis (in the hands of the distributing corporation immediately before the distribution) of the other property received, increased in the amount of gain to the distributing corporation which is recognized under subsection (b) or (c) of section 311.
'(2) Reduction for liabilities. -- The amount of any distribution determined under paragraph (1) shall be reduced (but not below zero) by --
'(A) the amount of any liability of the corporation assumed by the shareholder in connection with the distribution, and
'(B) the amount of any liability to which the property received by the shareholder is subject immediately before, and immediately after, the distribution.
'(3) Determination of fair market value. -- For purposes of this section, fair market value shall be determined as of the date of the distribution.
'(c) Amount taxable. -- In the case of a distribution to which subsection (a) applies --
'(1) Amount constituting dividend. -- That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income.
'(2) Amount applied against basis. -- That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock.
'(3) Amount in excess of basis. --
'(A) In general. -- Except as provided in subparagraph (B), that portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property.
'(B) Distributions out of increase in value accrued before March 1, 1913. -- That portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock and to the extent that it is out of increase in value accrued before March 1, 1913, shall be exempt from tax.
'(d) Basis. -- The basis of property received in a distribution to which subsection (a) applies shall be --
'(1) Noncorporate distributees. -- If the shareholder is not a corporation, the fair market value of such property.
'(2) Corporate distributees. -- If the shareholder is a corporation, whichever of the following is the lesser:
'(A) the fair market value of such property; or
'(B) the adjusted basis (in the hands of the distributing corporation immediately before the distribution) of such property, increased in the amount of gain to the distributing corporation which is recognized under subsection (b) or (c) of section 311.'
' § 316. Dividend defined
'(a) General rule. -- For purposes of this subtitle, the term 'dividend' means any distribution of property made by a corporation to its shareholders --
'(1) out of its earnings and profits accumulated after February 28, 1913, or
'(2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made. Except as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits. To the extent that any distribution is, under any provision of this subchapter, treated as a distribution of property to which section 301 applies, such distribution shall be treated as a distribution of property for purposes of this subsection.'
' § 331. Gain or loss to shareholders in corporate liquidations
'(1) Complete liquidations. -- Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock.
'(2) Partial liquidations. -- Amounts distributed in partial liquidation of a corporation (as defined in section 346) shall be treated as in part or full payment in exchange for the stock.
'(b) Nonapplication of section 301. -- Section 301 (relating to effects on shareholder of distributions of property) shall not apply to any distribution of property in partial or complete liquidation.'
' § 901. Taxes of foreign countries and of possessions of United States
'(a) Allowance of credit. -- If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under section 902. Such choice may be made or changed at any time prior to the expiration of the period prescribed for making a claim for credit or refund of the tax against which the credit is allowable. The credit shall not be allowed against the tax imposed by section 531 (relating to the tax on accumulated earnings), against the additional tax imposed for the taxable year under section 1333 (relating to war loss recoveries), or against the personal holding company tax imposed by section 541.
'(b) Amount allowed. -- Subject to the limitation of section 904, the following amounts shall be allowed as the credit under subsection (a):
'(1) Citizens and domestic corporations. -- In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; * * *.'
' § 902. Credit for corporate stockholder in foreign corporation
'(a) Treatment of taxes paid by foreign corporation. -- For purposes of this subpart, a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall be deemed to have paid the same proportion of any income, war profits, or excess profits taxes paid or deemed to be paid by such foreign corporation to any foreign country or to any possession of the United States, on or with respect to the accumulated profits of such foreign corporation from which such dividends were paid, which the amount of such dividends bears to the amount of such accumulated profits.'
' § 904. Limitation on credit
'(a) Limitation. -- The amount of the credit in respect of the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken which the taxpayer's taxable income from sources within such country (but not in excess of the taxpayer's entire taxable income) bears to his entire taxable income for the same taxable year.'
The pertinent question is whether the liquidating distribution from Filcrest to Automatic is included within the meaning of the term 'dividends' as that term is used in Section 902(a), so as to qualify it for the so-called 'deemed to be paid credit' provided in that section.
The plaintiff's arguments in support of its contention in substance are as follows:
1. The term 'dividends' as used in Section 902(a) of the 1954 Code is specifically defined in Section 316(a), 26 U.S.C.A. § 316(a), thereof for purposes of the entire income tax law; it clearly includes liquidating dividends as well as ordinary dividend distributions.
2. Under Section 238(e) of the Revenue Act of 1921 (the earliest predecessor of Section 902(a) of the 1954 Code), the term 'dividends' as used therein was intended by the Congress and interpreted by the Treasury Department to include liquidating dividends of the type involved herein; and there is nothing in the legislative history of any subsequent act of Congress indicating a Congressional intent to revise the tax treatment of such liquidating dividends under the foreign tax credit provisions of the income tax law.
3. The term 'dividends' as used elsewhere in the same subchapter of the 1954 Code in which Section 902(a) is located has been held to include liquidating dividends, and the same term as used in Section 902(a) must be construed in pari materia therewith.
4. Treatment of the liquidating distribution in question as a 'dividend' is consistent with and supported by the Income Tax Convention between the United States and the Dominion of Canada and the taxation of such distribution as a 'dividend' by the Canadian tax authorities thereunder.
The defendant's arguments in support of its contention are as follows:
1. Section 331(b) of the 1954 Code, 26 U.S.C.A. § 331(b), expressly provides that 'Section 301 * * * shall not apply to any distribution of property in * * * complete liquidation.' Therefore, Section 316(a), which defines the term 'dividends,' cannot apply to a distribution in complete liquidation since the express language contained in this section makes the term 'dividends' applicable only to a 'distribution of property' to which Section 301, 26 U.S.C.A. § 301, applies.
2. The legislative history of Section 902(a) (and its predecessor sections) directly parallels that of Section 243(a) (and its predecessor sections). Since the term 'dividends' as used in Section 243(a), 26 U.S.C.A. § 243(a), does not include a distribution in liquidation, it follows that the term 'dividends' as used in Section 902(a) does not include a distribution in complete liquidation.
3. Congress did not intend to allow a foreign tax credit for liquidation distributions under Section 902(a), nor a dividend received deduction under Section 243(a). Congress could not have intended to treat a liquidating distribution as a sale or exchange for one purpose and as a 'dividend' for the purpose of Sections 902(a) and 243(a), since an interrelation of these two distinct concepts in respect to one distribution would produce absurd results in many cases.
4. The term 'dividends' as used in many other sections of the 1954 Code does not include a liquidating distribution. An interpretation of Section 902 (a) to include a liquidating distribution would, in effect, require a similar interpretation of the term as used in Sections 34, 116, 243(a), 244 and 247, 26 U.S.C.A. § 34, 116, 243(a), 244, 247.
5. The Income Tax Convention between the United States and the Dominion of Canada is completely irrelevant ...