1984 U.S. Tax Ct. LEXIS 49">*49
Golden Nugget, Inc., in 1974, exchanged debentures due in 1994 for about 11 percent of its outstanding common stock and here claims an annual deduction for original issue discount with respect to the difference between the principal amount of the debentures and the fair market value of the common stock at the time of the exchange.
83 T.C. 28">*28 OPINION
Respondent determined deficiencies in petitioners' Federal income tax as follows:
Year | Deficiency |
1975 | $ 12,974 |
1976 | 12,974 |
1977 | 12,973 |
1978 | 12,973 |
83 T.C. 28">*29 The only question for decision is whether there was original issue discount, as defined in
All of the facts are stipulated.
Petitioner Golden Nugget, Inc., which had its principal place of business in Las Vegas, NV, when it filed its petition, is the parent of an affiliated group of 1984 U.S. Tax Ct. LEXIS 49">*54 corporations filing consolidated Federal income tax returns with the Internal Revenue Service Center, Ogden, UT. Golden Nugget, Inc.'s subsidiary is also a petitioner in this case, but hereinafter all references to "petitioner" in the singular will refer only to Golden Nugget, Inc., because only its affairs are involved in the present controversy.
In September 1974, petitioner had outstanding 1,592,321 shares of common stock with a par value of $ 2.50 per share. The stock was publicly traded on the Pacific Stock Exchange. From the beginning of 1974 through September 20 of that year, its price on the exchange ranged from a low of $ 5.125, to a high of $ 7.50 per share.
On October 1, 1974, petitioner made an offer to its shareholders to exchange $ 10 principal amount of newly issued 12-percent subordinated debentures due in 1994 (the debentures) for each share of petitioner's common stock. The debentures were redeemable by petitioner at its election at any time after October 15, 1975. The purpose of the exchange offer, as set forth in an offering circular dated October 1, 1974, was as follows:
Purposes of Exchange Offer
Management believes that the GN Common Stock is presently 1984 U.S. Tax Ct. LEXIS 49">*55 undervalued and that its purchase for a consideration consisting of the Debentures will benefit the Company, its remaining stockholders and the Debenture holders. Management also believes that it is in the best interests of stockholders to afford them a choice either to become holders of the Debentures, or to remain stockholders subject to possible increased risks and 83 T.C. 28">*30 potential for increased benefits that may result from the increased indebtedness of GN resulting from the issuance of the Debentures and the concomitant decreased amount of GN Common Stock to be outstanding. In addition, management believes that future discussions concerning sale of the Company, if any, would involve terms more favorable to remaining stockholders than would have been the case had the Exchange Offer not been consummated. There are at present no such discussions. * * *
Petitioner agreed to accept all shares which were tendered up to 400,000 and had the option to accept any shares in excess thereof up to a total of 800,000 shares. 2 Pursuant to the exchange offer, petitioner acquired a total of 181,718 shares of its common stock by the end of October 1974 (the 1974 exchange). The shares were1984 U.S. Tax Ct. LEXIS 49">*56 not retired but were held by petitioner as treasury stock.
1984 U.S. Tax Ct. LEXIS 49">*57 At the time of the exchange offer, the value of the common stock, based on the price at which it was traded on the Pacific Stock Exchange, was somewhat in excess of $ 7 per share. The excess of the principal amount of the debentures ($ 10 principal amount for each share of stock) over the market value of the common stock acquired by petitioner amounted to $ 540,573 (the discount amount).
After the 1974 exchange was consummated, petitioner claimed deductions for the amortization of the discount amount for the remainder of 1974 and for the balance of the period here in controversy. The determined deficiencies arise from the disallowance for each year in dispute of $ 27,029 deducted by petitioner as amortization of the discount amount.
Section 163(a) provides for the deduction of "all interest paid or accrued within the taxable year on indebtedness." If a bond 83 T.C. 28">*31 is issued for an amount less than its face amount, the amount of the difference, called "original issue discount," represents interest expense and may in general be amortized and deducted as interest over the life of the obligation. See
The term "original issue discount" is defined in
In the case of a bond or other evidence of indebtedness, * * * (other than a bond or other evidence of indebtedness * * * issued pursuant to a plan of reorganization within the meaning of (A) is part of an issue a portion of which is traded on an established securities market, or (B) is issued for stock or securities which are traded on an established securities market,
See also
Thus, where the "established securities market" requirement of
By its terms,
Respondent contends that the debentures were issued as part of a reorganization in the form of a recapitalization under
1984 U.S. Tax Ct. LEXIS 49">*62 The term "recapitalization" as used in
In a number of decided cases, exchanges by corporations of newly issued debentures for outstanding stock have been held 83 T.C. 28">*33 to qualify as reorganizations described in
1984 U.S. Tax Ct. LEXIS 49">*64 It is clear that the 1974 exchange effected a recapitalization of petitioner. Just prior to the exchange offer, petitioner had 1,592,321 shares of common stock outstanding. It offered to exchange debentures for 400,000 shares, about 25 percent, of its stock, and had the option of accepting 800,000 shares, about 50 percent, of its stock in exchange for debentures. Even the ultimate acceptance of 181,718 shares of its stock constituted a significant shift of funds within the corporate structure, sufficient to qualify as a recapitalization. We hold, therefore, 83 T.C. 28">*34 that petitioner's 1974 exchange of its debentures for its common stock was an E reorganization and that, consequently, the 1974 exchange did not produce original issue discount.
Petitioner argues that the 1974 exchange was not an E reorganization, and thus not within the exception to the general rule of
1984 U.S. Tax Ct. LEXIS 49">*66 We do not think these general statements in the regulations apply to a reorganization in the form of a recapitalization. The continuity-of-interest doctrine apparently had its roots in
The term [reorganization] does not embrace the mere purchase by one corporation of the properties of another corporation, for it imports a continuity of interest on the part of the transferor or its shareholders in the properties transferred. 1984 U.S. Tax Ct. LEXIS 49">*68 * * *
We think it reasonably clear, therefore, that the general statements quoted above from
Respondent does not seriously argue that there was a continuity of interest on the part of the exchanging shareholders in the 1974 exchange, but he contends that the transaction was nonetheless an E reorganization because the continuity-of-interest requirement is inapplicable to such reorganizations. Respondent's position is supported by this Court's holding in
It is quite apparent that the considerations which make such a doctrine necessary in the merger and consolidation cases are simply not present in a recapitalization. A recapitalization of a single corporation often contemplates some change in interest, such as from stockholder to bondholder, and 83 T.C. 28">*36 in a sense such a change might always be called an interruption of continuity. * * * It cannot be1984 U.S. Tax Ct. LEXIS 49">*69 that the term "recapitalization" in the statute includes a requirement of the continuance of the old interest in proprietary form when recapitalization plans so often contemplate converting such interest to a nonproprietary form. We think that the "continuity of interest" doctrine has no application to a recapitalization such as took place in the instant case. [Fn. ref. ommitted.] 9
1984 U.S. Tax Ct. LEXIS 49">*70 Petitioner contends, however, that statutory changes between the time of the transaction presented in
(1) In General. -- 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.
During the years here before the Court, however, the following exception to the section 354(a)(1) rule of nonrecognition was provided in section 354(a)(2), which had no predecessor 1984 U.S. Tax Ct. LEXIS 49">*71 in the 1939 Code:
(2) Limitation. -- Paragraph (1) shall not apply if -- (A) the principal amount of any such securities received exceeds the principal amount of any such securities surrendered, or (B) any such securities are received and no such securities are surrendered.
We do not agree with petitioner, however, that the 1974 exchange was not a reorganization simply because the recipients of the debentures may have recognized gain on the transaction. Although the addition of section 354(a)(2) to the Code in 1954 changed the
section 354 provides rules for exchanges by shareholders and security holders in reorganizations described in
Section 354(a) is derived from
These passages confirm that, in enacting the 1954 Code, Congress did not intend to change the definition of an E reorganization, but merely contemplated that securities received by shareholders in such reorganizations in excess of the principal amount of those surrendered will be taxed as "boot" under section 356. The 1974 exchange was, therefore, an E reorganization even though there was no continuity of proprietary interest and even though the transaction resulted in taxable gain to the shareholders involved.
83 T.C. 28">*38 Our view in this regard is consistent with that of the Court of Appeals for the Second Circuit in the recently decided case of
While section 354(a)(2)(B) would have required a different result if it had been in effect when the cases were decided under the 1939 Code, it would have done so only insofar as the taxability of the exchange to the shareholders was involved. Section 354(a)(2)(B) does not purport to define recapitalization; indeed, the term is not mentioned. As stated above, the 1954 Code reenacted the 1939 Code definition of reorganization without change and without definition of recapitalization. We conclude that section 354(a)(2)(B) does not bear on the issue before us. * * *
In short, contrary to Microdot's arguments, the definition of reorganization, with its inclusion of recapitalization, does not incorporate any reference to the tax consequences of a transaction to the shareholders.
[Fn. ref. omitted.]
Petitioner argues that the 1974 exchange was not a reorganization for the additional reason that it was not motivated by an appropriate business purpose. Like the continuity-of-interest requirement, the business purpose requirement is not prescribed by the Code, 1984 U.S. Tax Ct. LEXIS 49">*75 itself, but was developed through judicial decisions. Thus, in
1984 U.S. Tax Ct. LEXIS 49">*76 We agree with petitioner that a valid business purpose is a requirement of an E reorganization, but we do not find such a purpose lacking in the present case.
We note initially that the business purpose doctrine has historically been used by the courts as a rationale for disregarding transactions which have as their purpose "one which defeats or contradicts the apparent transaction."
As set forth above, the offering circular stated management's belief that the 1974 exchange would benefit "the Company, its remaining stockholders and the Debenture holders." On brief, petitioner states that it decided to acquire some of its outstanding stock because it considered the stock to be "undervalued and a good buy at the time." In other words, petitioner concedes that it entered into the 1974 exchange because it believed that the transaction would increase the value of the remaining stock while giving those shareholders choosing to surrender their stock increased security and a fixed rate of return. The surrendered stock, however, was not canceled but was held as treasury stock subject to resale by 83 T.C. 28">*40 petitioner. The 1974 exchange no doubt affected the future marketability of petitioner's stock and, significantly, petitioner's outstanding stock rose from approximately 1,590,000 shares in 1974 to 5 million shares in 1979. The transaction was not undertaken for reasons of tax avoidance, nor was there any attempt to conceal its true character. It was exactly what it purported to be, an exchange1984 U.S. Tax Ct. LEXIS 49">*78 of debt for equity undertaken for sound economic reasons. Accordingly, there was a business purpose for the transaction. 11
Petitioner next argues that, even if the 1974 exchange did constitute an E reorganization, it should still not be considered a reorganization for purposes of the
The bill which became the Tax Reform Act1984 U.S. Tax Ct. LEXIS 49">*79 of 1969, as approved by the House and by the Senate Finance Committee, would have amended
The reorganization problem arises because in a tax-free reorganization, no gain or loss is recognized to the corporations involved and the basis of the assets of the transferor corporation carries over, that is, such assets have the same basis in the hands of the transferee corporation. Under these 83 T.C. 28">*41 circumstances, original issue discount should not be taken into account so as to give the transferee corporation an amortization deduction as a result of the issuance of its bonds in the reorganization. In other situations, 1984 U.S. Tax Ct. LEXIS 49">*80 the issuing corporation pays a price where there is original issue discount because the basis of the assets is their lower value at the time the bonds are issued rather than the face amount of the bonds. In a reorganization, however, where the basis of the assets carries over, this "leveling" factor does not exist and there is every reason for the issuing corporation to claim a low value for the assets to increase its amortization deduction for bond discount if such a deduction is allowed. Thus, the danger of the Government being whipsawed is even greater.
* * * *
We therefore recommend that a floor amendment be offered * * * [under which] original issue discount will not be deemed to exist where a bond is issued in a "reorganization" as defined in
Senator Williams responded to Mr. Nolan's letter by offering an amendment which contained the exception for "[bonds] * * * issued pursuant to a plan of reorganization," which was subsequently enacted. 13
Petitioners argue that --
the Nolan letter and such legislative history as exists relating to the floor amendment show that the amendment was intended to preclude original issue discount where bonds are issued for property pursuant to a
It is thus true that the reorganization exception in
83 T.C. 28">*42 We are, however, confronted with an unambiguous statute drafted in anticipation of the general problem at hand. Mr. Nolan's letter to Senator Williams indicated that the Treasury Department was concerned that the definition of "original issue discount" contained in the bill as it then stood was too broad. Petitioner has argued skillfully that the exception carved out of that definition for "[bonds] * * * issued pursuant to a plan of reorganization" was itself too broad a response to the problem perceived. But the exception was, nonetheless, the one which Congress enacted, and we are bound to give effect to the plain words of the statute. 14 Therefore, our holding that the 1974 exchange was a reorganization requires us also to conclude that it was within the exception to the general rule of
1984 U.S. Tax Ct. LEXIS 49">*83 Reaching this same conclusion in
Having reached this conclusion, we wish to point out that in
Petitioner also argues that, prior to the issuance of
We need not consider this argument because our holding that the 1974 exchange was an E reorganization is not based on the revenue ruling, but on our own reading of
Finally, petitioner argues that, because it relied on respondent's former position that a transaction like the 1974 exchange did not qualify as an E reorganization, respondent should be equitably estopped from applying to petitioners his new position stated in
To reflect the foregoing,
1. All section references are to the Internal Revenue Code of 1954 as amended, unless otherwise indicated.↩
2. The offering circular also set forth the opinion of petitioner's counsel as to the Federal income tax consequences of the proposed exchange including the tax consequences of original issue discount. The opinion of counsel, as set forth in the offering circular, stated:
"4. If the fair market value of the Debentures on the Expiration Date is less than their principal amount, the excess of the principal amount over their fair market value on such date (the "original issue discount") will be required to be taken into ordinary income by each holder of a Debenture, ratably each year over the period remaining to the maturity of the Debenture, so long as such holder continues to hold the Debenture. * * *
"5. The Company will recognize neither a gain or a loss on the Exchange Offer for federal income tax purposes. However, the Company will be entitled to an income tax deduction for any original issue discount which may be includable in the income of the holders of the Debentures as set forth in Paragraph 4 above."
Petitioner entered into the exchange with the expectation, based upon the advice of counsel, that for Federal income tax purposes it would be entitled to deduct any original issue discount arising on the issuance of the debentures ratably over the life of the instruments.↩
3. With respect to corporate bonds issued after May 27,
"If an obligation is issued by a corporation with original issue discount, the amount of such discount is deductible as interest and shall be prorated or amortized over the life of the obligation. * * * in general, the amount of original issue discount equals the excess of the amount payable at maturity over the issue price of the bond (as defined in paragraph (b)(2) of
4. The exception to the general rule of
5. See note 3
6. Respondent cites
"An exchange which is not pursuant to a reorganization * * * is an exchange in which the obligation or investment unit is not issued pursuant to a plan of reorganization within the meaning of
7. All of these cases, except
A stock-for-bonds exchange was found not to constitute an E reorganization in
"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. * * * [
The record indicates that the bonds in the present case were not distributed pro rata to all stockholders, as were the bonds in
8. The following statement of the continuity-of-interest doctrine is found in
"While no precise formula has been expressed for determining whether there has been retention of the requisite interest, it seems clear that * * * [there must be] a showing: (1) that the transferor corporation or its shareholders retained a substantial proprietary stake in the enterprise represented by a material interest in the affairs of the transferee corporation, and, (2) that such retained interest represents a substantial part of the value of the property transferred. [Fn. ref. omitted.]"↩
9. The Court's opinion on this point in
10. See also
"scheme, which involves an abrupt departure from normal reorganization procedure in connection with a transaction on which the imposition of tax is imminent, such as a mere device that puts on the form of a corporate reorganization as a disguise for concealing its real character, and the object and accomplishment of which is the consummation of a preconceived plan having no business or corporate purpose, is not a plan of reorganization."↩
11. In view of petitioner's declaration that the 1974 exchange benefited both the corporation and its shareholders, we need not deal with the question whether only the benefits of the corporation may be considered. See
12. The bill provided as follows:
"In the case of a bond or other evidence of indebtedness * * * as described in this paragraph, issued for property, the issue price of such bond or other evidence of indebtedness * * * shall be the fair market value of such property. [H.R. 13270, 91st Cong., 1st Sess., sec. 413(b) (1969).]"
H. Rept. 91-413 (1969),
13. The legislative history of this provision is reviewed in greater detail in
14. As the Supreme Court has stated, the courts should look to the legislative history of the statute "to solve doubt and not to create it."
15. As two commentators have noted:
"The distinction between quasi-estoppel and abuse of discretion is more of terminology than of substance since both labels are grounded upon quite similar foundations. [Lynn & Gerson, 'Quasi-Estoppel and Abuse of Discretion as Applied Against the United States in Federal Tax Controversies,'