Waterman, Friendly and Anderson, Circuit Judges.
O.B.M., Inc., and its six individual shareholders appeal from decisions of the Tax Court, 52 T.C. 619 (1969), upholding the Commissioner of Internal Revenue's determination of their liability for deficiencies based on the corporation's failure to comply with the 12-month liquidation procedure of § 337(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 337(a). We reverse.
O.B.M., Inc., is the current name of a New York corporation through which various members of the O'Brien and McAllister families have engaged in marine dredging and transportation operations since 1906. In 1958, it sold substantially all its operating assets to Tidewater Dredging Corp., a firm with which some members of the two families are also involved. In return, O.B.M. received 50 per cent of both the Tidewater common and preferred stock.
On or about June 19, 1961, the stockholders of Tidewater voted to sell all its physical assets to Great Lakes Dredge and Dock Co., an unrelated Chicago firm, for $2,150,000. On June 23, both the Tidewater stockholders and those of its 50 per cent parent O.B.M. adopted plans of complete liquidation calling for distribution within 12 months of all assets not necessary to meet claims. Gerard M. McAllister, an attorney who was a stockholder and an officer of both firms, was appointed trustee in liquidation of the two companies. Louis J. Riso, O.B. M.'s treasurer and Tidewater's financial vice-president, was designated to handle the details under both plans.
Tidewater completed its planned distributions on February 28, 1962, the day on which its 1961-62 fiscal year ended. After receiving the proceeds of the sale of its assets to Great Lakes and after satisfying various creditors, Tidewater distributed a total of $834,060 to O.B.M. and other sums to the remaining owners. None of Tidewater's shareholders surrendered his stock to the corporation as a result of these liquidating distributions.
At the close of this fiscal year, Tidewater's books showed assets of $128,653, largely in the form of accounts receivable, and itemized liabilities of only $12,837. But the annual report explained that this balance sheet, indicating a remaining stockholders' equity of $115,816, did not reflect three additional contingent liabilities: (1) retroactive workmen's compensation premiums of approximately $51,000; (2) estimated liability to the owner of the vessel Judi Bob for $20,000 damages above the $500 shown for this claim on the books; and (3) possible liability in connection with unaudited federal, state, and local tax returns.
By the end of its own 12-month liquidation period in June of 1962, the parent firm, O.B.M., made cash distributions totaling $1,127,000 to its six shareholders: Burton O'Brien, Gerard M. McAllister, Anthony J. McAllister, James P. McAllister, Roderick H. McAllister, and Charles D. McAllister. It also distributed to them its shares in Mersick Industries, Inc., an apparently unrelated company. On June 23, 1962, O.B.M.'s books showed remaining ascertained assets of $5,099 and liabilities of approximately $8,000. The largest component of the latter sum was a $4,416.61 tax judgment, with interest then calculated at $1,300, for which O.B.M. was liable to the City of New York, and which had arisen from a joint venture in which O.B.M. had participated. In addition, several of O.B.M.'s federal, state, and local tax returns also remained unaudited.
Along with its ascertained assets and these assorted liabilities, O.B.M. also retained three other asset items: (1) an inoperative tugboat, the DuBois II, with an estimated scrap value of $3,000-$5,000; (2) its interest in a lawsuit against the City of New York arising out of a pier demolition contract performed by the aforementioned joint venture; and (3) its half of the uncancelled Tidewater stock.
Both companies filed tax returns indicating no corporate-level income as a result of the disposition of their assets, in what they assumed to be compliance with § 337(a).*fn1
As a result of the reconciling of assorted contingent claims, however, both Tidewater and O.B.M. distributed additional sums to their respective shareholders after the close of the specified 12month liquidation period. During 1963, federal tax authorities did in fact assert the anticipated deficiency against the operating company, Tidewater, in the sum of approximately $30,000 plus interest; but this claim was settled for an unspecified amount during that year. In addition, Tidewater settled its workmen's compensation liability in 1963 for less than the previously allocated $51,000. In 1964, it satisfied its damage liability to the owner of the Judi Bob for $4,900 instead of the expected $20,000. As a result, it made three post-1962 distributions to its half-owner O.B.M., totaling $36,454. Still further, O.B.M. itself realized a total of $6,000 (including an unforeseen forfeited purchase deposit of $2,000) on its sale of the tug DuBois II for scrap; and it also settled its joint venture lawsuit against New York City in exchange for a compromise of the City's tax judgment and a net cash sum of $12,859.83. As a result of these five separate turns of good fortune benefiting Tidewater and itself, taxpayer O.B. M. was able to distribute an additional $47,000 to its six shareholders between 1962 and 1966.
In summary, the $2 million dredging and towing business with which both firms were involved was substantially wound up over a period of several years; but in the process, about 4 per cent of O.B.M.'s total distributions were made after the 12-month period specified in its liquidation plan. For this reason, the Commissioner determined deficiencies in O.B.M.'s taxes of $63,594.73 plus interest for the years 1961-1963. He also determined that each of the firm's six shareholders is liable as a transferee for this total amount pursuant to 26 U.S.C. § 6901.
Congress enacted § 337(a) to allow the owners of liquidating corporations to obviate double capital gains taxation otherwise imposed by a tax on the corporation when it sells capital assets and another on the stockholders when the proceeds are distributed. See West Street-Erie Blvd. Corp. v. United States, 411 F.2d 738, 740-741 (2 Cir. 1969). Consequently, a corporation which distributes all its assets other than those retained to meet claims within a 12-month period after its adoption of a liquidation plan may relieve its owners of concern with some of the formalities which previously governed the tax consequences of such a transaction. See C.I.R. v. Court Holding Co., 324 U.S. 331, 65 S. Ct. 707, 89 L. Ed. 981 (1945); United States v. Cumberland Public Service Co., 338 U.S. 451, 70 S. Ct. 280, 94 L. Ed. 251 (1950).
The statute authorizes a liquidating corporation to retain only those assets needed to meet claims outstanding after the close of the 12-month period, without approving retention of assets, large or small, for any other purpose. But it has never been suggested that O.B.M. or its shareholders caused the corporation to retain the $47,000 in question for any other specific use besides meeting claims. In addition, it appears that the individual shareholders' tax consequences were not significantly affected by the retention and delayed distribution, so that there was no tax motive for a conscious shaping of the liquidation along these lines.*fn2 The Commissioner ...