Parshelsky v. Commissioner

Estate of Moses L. Parshelsky, Deceased, Lawrence A. Baker, Clarence G. Bachrach, Isidore Schwartz and Abraham Parshelsky, Executors, Petitioners, v. Commissioner of Internal Revenue, Respondent Parshelsky v. Commissioner Docket No. 70212 United States Tax Court 34 T.C. 946; 1960 U.S. Tax Ct. LEXIS 76; September 15, 1960, Filed *76 Decision will be entered for the respondent. Distribution by a corporation to its sole stockholder of the shares of a newly organized, wholly owned subsidiary to which part of the corporation's property had been transferred, held, on the facts, not pursuant to a "reorganization" nor to come within the nonrecognition provisions of section 112(b)(11), I.R.C. 1939. Lawrence A. Baker, Esq., for the petitioners. Clarence P. Brazill, Jr., Esq., for the respondent. Opper, Judge. OPPER *946 Respondent has determined a deficiency of $ 311,637.89 in the income tax of Moses L. Parshelsky, deceased, for the year 1954. The deficiency results from respondent's addition of $ 360,000 to 1954 income as a taxable dividend, representing the value of the stock of a newly formed subsidiary corporation distributed to him by a wholly owned parent corporation. The issue is whether the nonrecognition provisions of section 112(b)(11), I.R.C. 1939, apply to this distribution. *947 FINDINGS OF FACT. The above-named individual petitioners are the executors of the estate of Moses L. Parshelsky, hereinafter referred to as the decedent, who died March 13, 1955. For many years prior to his death decedent was the sole stockholder *77 of Parshelsky Brothers, Inc., hereinafter called Brothers, a corporation engaged in the operation of a wholesale lumber and millwork business located at Maserole Street and Morgan Avenue in Brooklyn, New York. The business was formerly conducted as a partnership by the decedent and a brother, Isaac. In 1908 it was incorporated and shortly thereafter all of the company's capital stock was acquired by decedent. Brothers owned the real estate on which its business was conducted which consisted of approximately 65,500 square feet of land with a 1-story brick building containing about 50,000 or 60,000 square feet of floorspace. The building was used for warehouse, workrooms, and office purposes. It had a high ceiling, with bins and racks arranged for storing inventory, such as doors, window frames, sashes, and other building items. Decedent was active in the conduct of the business and personally handled or supervised most of the office work. In his later years he became concerned about what would happen to the business after his death. He intended to make, and did make, provision in his will for some of the employees to continue the business after his death under very favorable conditions. *78 However, he did not want to have the real estate, which was a valuable asset of the business, remain under Brothers' management and subject to the hazards of the business. Also, he wanted the real estate left so that it would be readily available to his executors as a separate asset of the estate. After consultation with his lawyer and accountant, decedent caused a new corporation, Parshelsky Realties, Inc., hereinafter referred to as Realties, to be organized and, pursuant to a resolution of the board of directors of Brothers adopted December 18, 1953, that corporation transferred to Realties all of the above-described real estate in exchange for all of Realties' capital stock which was immediately distributed to decedent as Brothers' sole stockholder. The resolution provided in part as follows: Whereas the operation of this corporation's business is not dependent upon the ownership of said real estate but can be efficiently and profitably carried on in all respects under a leasehold thereof; and in the event of an ultimate disposition of the business occasioned by reason of the retirement of the corporation's sole stockholder or otherwise, such disposition will be facilitated by *79 previously disposing of such part of the corporation's property as is not required for the efficient operation of its business; and *948 Whereas both the present and future welfare of the corporation would be promoted by a reorganization, whereby this corporation would convey its said real estate to a new, separate corporation, organized to function as a real estate corporation, which new corporation would issue its entire capital stock to this corporation in exchange for said real estate, and all of the said stock would then be assigned by this corporation to its sole stockholder; * * * * * * * RESOLVED: (1) That in the judgment of this Board it is advisable and for the best interests of this corporation to effect a reorganization whereby the real estate of this corporation, * * * will be conveyed to the new corporation, Parshelsky Realties, Inc., and the entire capital stock of said new corporation, consisting of 100 shares of common stock, all of one class, having a par value of $ 100. per share, will be issued to this corporation and will thereupon be distributed by this corporation to its stockholders in proportion to their respective holdings of stock in this corporation; and (2) That *80 said plan of reorganization be, and hereby is, approved and adopted; that this corporation shall offer a conveyance of its said real estate to said Parshelsky Realties, Inc. in exchange for the issuance to this corporation of the entire capital stock of Parshelsky Realties, Inc., consisting of 100 shares of common stock, all of one class, having a par value of $ 100. per share; that upon the acceptance of said offer this corporation shall convey its said real estate to said Parshelsky Realties, Inc., for which property this corporation shall receive the said entire capital stock of said new corporation; and that upon receiving said stock this corporation shall assign and distribute all of said stock to its own stockholders in proportion to the number of shares of this corporation then held by them respectively; and (3) That simultaneously with the carrying out of said reorganization, this corporation as lessee shall enter into a lease of said real estate with said Parshelsky Realties, Inc. as lessor for such term of years and upon such terms and conditions as this corporation shall deem appropriate and reasonable; * * * As provided in the resolution, Realties leased the real estate back *81 to Brothers simultaneously with the transfer of the property. The lease was for a period of 5 years at an annual rental of $ 42,000 with an option for renewal for an additional 5-year term. It gave the lessee the right at any time to sublease for its own account up to 50 per cent of the floorspace and also provided that upon failure of the lessee at any time to utilize at least 50 per cent of the total area of the building in its own business the lessor might terminate the lease. The real estate had a fair market value of $ 360,000 at the time of the transfer to Realties. No interruption to Brothers' business was caused by the above-described transactions. The profit and loss results of the company's operations in each of the fiscal years ended January 31, 1950 to 1955, inclusive, are reflected in the following figures taken from its income tax returns for those years: *949 Comparative summary of Federal income tax returns for fiscal years ended Jan. 31 -- (In even dollars) [1952] Gross sales $ 1,186,336 $ 1,602,978 $ 1,413,308 Cost of goods 907,006 1,285,956 1,151,990 Gross profit 279,329 317,021 261,317 Interest 11,812 12,874 13,456 Officers (M.L.P.) 26,250 25,000 20,833 Salaries 57,541 64,206 76,487 Repairs 4,406 2,330 2,612 Interest 13,108 6,051 [793] Contributions 5,666 7,157 4,175 Other deductions 56,620 63,458 69,458 Taxes 14,342 18,627 15,319 Rent Total income 291,218 329,895 276,806 Deductions 183,562 193,898 194,822 Net 107,656 135,997 81,984 Federal tax 40,909 54,341 36,469 Net after tax 66,747 81,656 45,515 *82 Comparative summary of Federal income tax returns for fiscal years ended Jan. 31 -- (In even dollars) [1955] Gross sales $ 1,411,649 $ 1,252,739 $ 1,328,109 Cost of goods 1,148,874 991,980 1,044,079 Gross profit 262,774 260,758 284,029 Interest 13,456 14,830 14,327 Officers (M.L.P.) 18,747 20,833 6,250 Salaries 87,585 96,607 128,217 Repairs 2,333 15,274 2,647 Interest 1,982 3,139 None Contributions 1 3,338 2 1,600 3 168 Other deductions 79,323 82,713 98,428 Taxes 13,921 12,771 8,209 Rent 3,500 42,000 Total income 276,276 275,694 298,768 Deductions 212,854 245,279 295,572 Net 63,422 30,415 3,196 Federal tax 27,479 10,316 [942] Net after tax 35,943 20,099 2,254 Certain aspects of Brothers' financial condition in each of the years 1950 to 1954, inclusive, as shown in its income tax returns, were as follows: Fiscal year ending Jan. 31 -- [1954] Current assets: Cash $ 493,000 $ 355,000 $ 283,000 $ 354,000 $ 272,000 Accounts receivable 161,000 273,000 197,000 208,000 196,000 Inventory 202,000 285,000 380,000 327,000 381,000 Treasury notes 575,000 575,000 551,000 551,000 550,000 Mortgages 15,000 15,000 15,000 15,000 Interest received 6,000 10,000 4,000 4,000 5,000 Total current assets 1,452,000 1,513,000 1,430,000 1,459,000 1,404,000 Total assets 1,578,000 1,635,000 1,549,000 1,574,000 1,407,000 Total current liabilities 181,000 158,000 45,000 54,000 16,000 Earned surplus 397,000 477,000 504,000 521,000 391,000 Sec. 102 tax liability 18,703 23,107 12,778 4,662 2,052 *83 Decedent was advised by his attorney that notwithstanding the section 102 surtax it was to his advantage not to distribute the corporate earnings because his income tax on the distributions would be greatly in excess of the section 102 tax. The decedent was 81 years of age at the time of his death. He had never married. His only surviving relative was a brother, Abraham. In his will decedent made a number of specific bequests, the major portion of them to miscellaneous charities, created a trust fund in the principal amount of $ 200,000 for the benefit of his surviving brother for life, and left the residue of his estate to a previously created charitable foundation, Moses L. Parshelsky Foundation. *950 The remainder of the trust fund for the brother's benefit was also to go to the foundation upon his death. Decedent's will was executed March 14, 1951. By a codicil dated March 7, 1955, the executors were authorized in their discretion to continue the business of Brothers and to decide when and how it could best be liquidated. The decedent retained ownership of all of the capital stock of both Brothers and Realties until his death. OPINION. The issue here is somewhat narrowed by respondent's *84 concession, which is substantiated by the facts, that the transactions above described met the requirements for a nontaxable reorganization 1 except for the absence of a valid business purpose under the rule of Gregory v. Helvering, 293 U.S. 465. The Gregory decision turned on the meaning of the term "reorganization" as used in the revenue act, the Court saying that the statute speaks of a transfer made: "in pursuance of a plan of reorganization" * * * § 112(g) * * * of corporate business; * * * [Emphasis added.] as distinguished from: an operation having no business or corporate purpose * * * [Emphasis added.] Later in Bazley v. Commissioner, 331 U.S. 737, 741-742, the Court emphasized this restrictive *85 meaning of the term "reorganization" as used in section 112(g), saying: In a series of cases this Court has withheld the benefits of the reorganization provision in situations which might have satisfied provisions of the section treated as inert language, because they were not reorganizations of the kind with which § 112, in its purpose and particulars, concerns itself. See Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462; Gregory v. Helvering, 293 U.S. 465; Le Tulle v. Scofield, 308 U.S. 415. * * * * What is controlling is that a new arrangement intrinsically partake of the elements of reorganization which underlie the Congressional exemption and not merely give the appearance of it to accomplish a distribution of earnings. In the case of a corporation which has undistributed earnings, the creation of new corporate obligations which are transferred to stockholders in relation to their former holdings, so as to produce, for all practical purposes, the same result as a distribution of cash earnings of equivalent value, cannot obtain tax immunity because cast in the form of a recapitalization-reorganization. *951 The governing legal rule can hardly be stated more narrowly. *86 To attempt to do so would only challenge astuteness in evading it. And so it is hard to escape the conclusion that whether in a particular case a paper recapitalization is no more than an admissible attempt to avoid the consequences of an outright distribution of earnings turns on details of corporate affairs * * * [Emphasis added.] The term "business purpose" as related to reorganizations may not be any more capable of exact delineation than the term "reorganization" itself. But the concept of "purpose" now firmly embedded in the statement of the principle cannot be too far separated from "motive" or "intention." And in any event, we think that the requisite business purpose must be one relating to the business being carried on by the corporation, 2 or relating otherwise to the corporation's organization or functioning and not one arising from and serving only the personal or noncorporate-business interests of the stockholders. Section 112(b)(11) was added 3 to the 1939 Code by section 317 of the Revenue *87 Act of 1951. A statement from the report of the Senate Finance Committee accompanying the bill is set out below. 4*88 Further light on the history of the section is found in the statement contained in 96 Cong. Rec. 1980 (1950). 5*89 *90 *952 The facts here are simple. The distributing corporation, Brothers, was operating a long-established and prosperous lumber and millwork jobbing business. Its sole owner, the decedent, was of advanced age and was concerned chiefly with getting his personal affairs in order for his possible retirement and settlement of his estate. 6The corporation had a large accumulated surplus, and had paid section 102 surtax in several years. Among its many valuable assets was the real estate on which the business was being conducted. The decedent wanted this real estate separated from the going business of the corporation. The reasons advanced by witnesses at the trial were settlement of his estate and the removal of the real estate from the hazards of the business, should it be continued after his *91 death. To that end he had the real estate transferred to a newly created corporation, Realties, in exchange for Realties' stock and had the stock all distributed to himself. Thereafter, Realties leased the real estate back to Brothers and the business continued as before. While technically, as agreed, this was a distribution pursuant to a statutory reorganization, we can perceive in it no possible purpose to benefit the corporate business. To the contrary, it left the corporation without a valuable asset, the real estate on which the business was being conducted; and burdened with an annual rental charge of $ 42,000 -- far in excess of the amount of the 102 tax, see Adam A. Adams, infra -- for carrying on a business that in the current year yielded a profit of less than $ 20,000. Although the real estate was eliminated from corporate assets, *92 there remained upward of a million dollars in other property, including more than three-quarters of a million in cash and Government securities, which could have been seized by such imaginary creditors as might suddenly and unexpectedly appear. The same result would have been *953 reached by a distribution of the real estate directly to the sole stockholder. We must assume that decedent was advised by his tax attorney that this would result in a tax on the value of the realty as a distribution. 7 Actually then, the reorganization, in the words of the statute, was "used principally as a device for the distribution of earnings and profits." We know that these accumulated earnings were large, that they were beyond the reasonable *93 needs of the business, but that decedent could not lay his hands on them without payment of an additional tax, and that he must have been aware of all these factors. Avoiding this tax is the only purpose which, on this record, we can ascribe to the transaction. Certainly petitioner has not carried the burden of showing the contrary. And this, of course, is not enough. Gregory v. Helvering, supra.The new corporation, Realties, was not intended to engage in the active conduct of any separate related business such as in the example 8*94 given in the Commissioner's regulations (T.D. 5990, approved Feb. 17, 1953, amending Regs. 111, sec. 29.112(b)(11)-2). The same result was reached in Perry E. Bondy, 30 T.C. 1037. That case, it is true, was reversed by the Court of Appeals for the Fourth Circuit, 269 F. 2d 463. But as the following quotation (p. 466) will show, there was no difference of opinion as to the legal principles involved and the reversal was based purely on the reviewing court's interpretation of the facts: For the exception of 112(b)(11) to apply, it must be conceded, the reorganization has to be germane to the business *95 of the corporation. Gregory v. Helvering, 1935, 293 U.S. 465, 469 * * * But the facts already recited and uncontroverted flatly refute the Commissioner's position. They positively affirm that the preservation of the dealership was the centerpiece of the reorganization. The reorganization was *954 not dependent on the separation agreement or a divorce; it had a value to Market Motors irrespective of either. * * * [Emphasis added.] It is immaterial that the distribution was of the stock of the subsidiary corporation, and thus, as a practical matter, of the real estate rather than of cash or other liquid assets. As we said in Adam A. Adams, 5 T.C. 351, 357, affd. 331 U.S. 737, a distribution of the corporation's debentures can partake of the nature of a taxable dividend to the same extent as any other distribution of property or of the stock of a wholly different corporation. We find no error in the determination. Decision will be entered for the respondent. Footnotes 1. Actual was $ 23,712.80.↩ 2. Actual was $ 17,375.80↩ 3. Actual was $ 7,807.↩ 1. SEC. 112. RECOGNITION OF GAIN OR LOSS. [I.R.C. 1939]. (g) Definition of Reorganization. -- As used in this section (other than subsection (b)(10) and subsection (1)) and in section 113 (other than subsection (a)(22)) -- (1) The term "reorganization" means * * * (D) 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 shareholders or both are in control of the corporation to which the assets are transferred * * *↩ 2. Not "a transfer of assets by one corporation to another in pursuance of a plan having no relation to the business of either." Gregory v. Helvering, supra↩ at 469. (Emphasis added.) 3. SEC. 112. RECOGNITION OF GAIN OR LOSS. (b) Exchanges Solely in Kind. -- * * * * (11) Distribution of stock not in liquidation. -- If there is distributed, in pursuance of a plan of reorganization, to a shareholder of a corporation which is a party to the reorganization, stock (other than preferred stock) in another corporation which is a party to the reorganization, without the surrender by such shareholder of stock, no gain to the distributee from the receipt of such stock shall be recognized unless it appears that (A) any corporation which is a party to such reorganization was not intended to continue the active conduct of a trade or business after such reorganization, or (B) the corporation whose stock is distributed was used principally as a device for the distribution of earnings and profits to the shareholders of any corporation a party to the reorganization.↩ 4. "Section 317 of your committee's bill adds a new section 112(b)(11) of the code to provide for the nonrecognition of gain from the receipt of stock in corporate exchanges carrying out transactions known as spin-offs. * * * "This section has been included in the bill because your committee believes that it is economically unsound to impede spin-offs which break-up businesses into a greater number of enterprises, when undertaken for legitimate business purposes. * * *" (S. Rept. No. 781, 82d Cong., 1st Sess., p. 57; 1951-2 C.B. 458↩, 499.) 5. Mr. CAMP [sponsor of the bill in the House]. * * * "Section 126, distribution of stock on reorganization: This section of the bill provides for the nonrecognition of gain from the receipt of stock in certain corporate reorganizations known as 'spin-offs.' A typical 'spin-off' occurs where a part of the assets of the corporation is transferred to a new corporation in exchange for all the stock of the new corporation which is thereupon distributed to the stockholders of the original corporation without the surrender by them of any of the stock of the original corporation. "A similar provision was contained in section 112(g) of the Revenue Act of 1932 and prior acts but this was omitted in the Revenue Act of 1934 because the decision of the Board of Tax Appeals in Evelyn F. Gregory (27 B.T.A. 223 (1932)) indicated that such provision might be subject to abuse and held to apply to what was regarded as in substance the distribution of a dividend. The reversal of that decision in 69 F. (2d) 809 (CCA2, 1934), affirmed 293 U.S. 465 (1935), removed the danger of such abuse. Judicial and administrative interpretation of the law since 1934 has established safeguards which now prevent such abuse of the reorganization provisions. It is proposed to restore this provision to the law because it is believed that it is economically unsound to impede reorganizations which divide one corporate enterprise into a greater number of corporate enterprises where such division is undertaken for legitimate business purposes and is not a mere device for the distribution of a dividend. Where stock of a new corporation is distributed without the surrender of stock of the old corporation, the result is identical, in substance, with transactions in which stock of the new corporation is distributed in exchange for the surrender of either all or a portion of the stock of the old corporation -- transactions which give rise to no recognized gain under present law. It is not intended to change the existing law as to such transactions but to amend the law so as to permit in the future the same substantial result to be accomplished with the same tax consequences by a 'spin-off' reorganization, all three types of reorganizations being subject to the general limitations embodied in the Gregory case and subsequent decisions based thereon↩." (Emphasis added.) 6. Petitioners' brief phrases it that "[what] taxpayer intended to do was 'put his house in order' and so arrange the affairs of the corporations that, upon the happening of his retirement or death, those taking over would be on notice with respect to the manner in which the corporate assets were to be treated." (Pets'. reply brief, pp. 13, 14.)↩ 7. "One does not have to pursue the motives behind actions, even in the more ascertainable forms of purpose, to find, as did the Tax Court, that the whole arrangement took this form instead of an outright distribution of cash or debentures, because the latter would undoubtedly have been taxable income whereas what was done could, with a show of reason, claim the shelter of the immunity of a recapitalization-reorganization." ( Bazley v. Commissioner, supra↩ at 742-743.) 8. "Example 2. Corporation C owns and operates a department store. It decides to provide parking facilities for the customers of the store. In order to provide such facilities, Corporation C enters into a contract to purchase land adjacent to its premises. The purchase price of the land is $ 100,000 and it is estimated that the cost of developing the parking lot will be $ 50,000. In order to separate the operations of the parking lot from those of the department store, Corporation C transfers to a newly formed Corporation D $ 90,000 in cash and $ 90,000 in bonds, together with the contract for the purchase of the land, in exchange for all the stock of Corporation D, which stock is distributed pro rata among the shareholders of Corporation C. The purchase of the land is completed on the date fixed in the contract, and the parking facilities are developed and operated by Corporation D. There are no other relevant facts. The transfer of the cash, bonds, and contract to Corporation D in exchange for its stock is a reorganization under section 112(g)(1) and the distribution of stock (other than preferred stock) in Corporation D to the shareholders of Corporation C is within the terms of section 112(b)(11)." (T.D. 5990, 1953-1 C.B. 142↩, 144.)