1989 U.S. Tax Ct. LEXIS 80">*80
During its fiscal year ending June 30, 1975, petitioner was a large publicly held corporation with substantial operations in electronics, leather goods, and handicrafts. On June 30, 1975, petitioner transferred its leather goods and handicrafts operations to two new wholly owned corporations. Among the assets transferred were certain items of sec. 38 property. In November 1975, petitioner distributed the stock of these corporations to its shareholders in completion of a reorganization described in
92 T.C. 1165">*1165 By statutory 1989 U.S. Tax Ct. LEXIS 80">*81 notice dated January 15, 1987, respondent determined a deficiency in petitioner's Federal income tax for its fiscal year ending June 30, 1975, in the amount of $ 40,066. In its petition, petitioner claimed an overpayment of tax for that year. 1 After concessions, the 92 T.C. 1165">*1166 sole remaining issue is whether section 47(a) 2 requires petitioner to recapture in fiscal year 1975 a portion of the credit allowed in prior years pursuant to section 38.
FINDINGS OF FACT
Some of the facts are stipulated and are so found. The stipulation and attached exhibits are incorporated1989 U.S. Tax Ct. LEXIS 80">*82 by this reference. At the time its petition was filed, petitioner's principal place of business was in Ft. Worth, Texas.
During the year before us, petitioner engaged in three principal areas of business operations consisting of electronics operations, leather goods operations, and hobby and handicrafts operations. On May 24, 1975, petitioner's board of directors resolved:
That the officers of the corporation be, and hereby are, subject to statutory and regulatory requirements, authorized and directed to do those things, and to execute such documents as they may deem necessary to accomplish the creation of two new companies from the assets of the corporation, such companies to be entitled Tandycrafts, Inc. and Tex Tan-Hickok, Inc., and further, to issue to the shareholders of Tandy Corporation, pro rata, in the form of a tax-free dividend, the common stock of the two new companies.
Pursuant to this resolution, petitioner on June 10, 1975, caused the incorporation of Tandycrafts, Inc. (Tandycrafts), to which petitioner was to transfer its assets and liabilities related to its hobby and handicrafts operations. On the same date, petitioner caused the incorporation of Tandy Brands, 1989 U.S. Tax Ct. LEXIS 80">*83 Inc. (Tandy Brands), to which it was to transfer the assets and liabilities related to the leather goods operations. Both transfers of assets and liabilities occurred on June 30, 1975, the last day of petitioner's fiscal year. In return, petitioner received all the stock of the two new corporations. Included among the assets transferred by petitioner to Tandycrafts and Tandy Brands were items of section 38 property, with respect to which the transfer occurred before the close of the useful life which was taken into account in computing the credit previously allowed under section 38.
92 T.C. 1165">*1167 Petitioner had several business reasons for engaging in the transactions. Petitioner's management had determined that infusions of capital were essential for each of petitioner's divisions to attain a greater degree of growth. This was especially true with respect to petitioner's electronics division, Radio Shack, for which management had plans of expansion in pursuit of a greater share of the U.S., Canadian, Australian, and European markets. However, for various reasons the present corporate structure made it difficult, if not impossible, for petitioner to obtain additional debt or equity1989 U.S. Tax Ct. LEXIS 80">*84 financing. For this reason, as well as friction between upper management of the various divisions and the health of petitioner's chairman and chief executive officer, management viewed a spin-off of the leather goods and handicrafts operations as the most desirable option.
On May 28, 1975, petitioner requested a ruling from the Internal Revenue Service (IRS) regarding the income tax consequences of the transaction. Specifically, petitioner sought IRS assurance that the transfer of assets and subsequent distribution of stock qualified as a tax-free reorganization under
On June 30, 1975, Tandycrafts and Tandy Brands filed a registration statement and prospectus with the Securities and Exchange1989 U.S. Tax Ct. LEXIS 80">*85 Commission (SEC) with respect to the distribution of their stock by petitioner. On October 9, 1975, the SEC declared the registration statement effective as of October 8, 1975, at 5:00 p.m. The distribution of the shares of the two subsidiaries would not have been made without the favorable tax ruling and an effective registration statement.
Sometime in November 1975, petitioner distributed its shares of Tandycrafts and Tandy Brands stock to petitioners' shareholders. The distribution was made on the basis of one Tandycrafts share for two of petitioner's shares, and one Tandy Brands share for every 10 shares of petitioner's stock.
92 T.C. 1165">*1168 OPINION
Section 47(a)(1) requires a taxpayer to recapture investment credits claimed in prior years pursuant to section 38 whenever the underlying property "is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the useful life which was taken into account in computing the credit under section 38 * * *." Section 47(b) provides an exception to this rule when section 38 property is disposed of "by reason of a mere change in the form of conducting the trade or business so long as the property1989 U.S. Tax Ct. LEXIS 80">*86 is retained in such trade or business as section 38 property and the taxpayer retains a substantial interest in such trade or business."
(a) The section 38 property * * * is retained as section 38 property in the same trade or business,
(b) The transferor * * * of such section 38 property retains a substantial interest in such trade or business,
(c) Substantially all the assets (whether or not section 38 property) necessary to operate such trade or business are transferred to the transferee to whom such section 38 property is transferred, and (d) The basis of such section 38 property in the hands of the transferee is determined in whole or in part by reference to the basis of such section 38 property in the hands of the transferor.
However, if at any time after a mere change in form the property ceases to be section 38 property with respect to the transferee before the close of the period used to calculate the credit, the exception contained in section 47(b) will cease to apply and recapture will1989 U.S. Tax Ct. LEXIS 80">*87 be required under section 47(a)(1).
A transferor is considered as having retained a substantial interest in the trade or business only if, after the change in form, the transferor's interest in the trade or 92 T.C. 1165">*1169 business is substantial in relation to the total interest of all persons, or equal to or greater than the transferor's interest prior to the change in form.
1989 U.S. Tax Ct. LEXIS 80">*89 The parties agree that there is no case law or other authority directly on point. Respondent on brief relies in part upon the following example from section 47's legislative history:
We agree with respondent that this example superficially implies that recapture is appropriate upon the transfer1989 U.S. Tax Ct. LEXIS 80">*90 of assets to a wholly owned subsidiary rather than upon the distribution of the subsidiary's stock. However, it provides little support for respondent's position, as it does not purport to involve a transfer and distribution occurring over more than one year.
After this case had been tried and briefed, respondent formally expressed his opinion on this issue in
While respondent does not in the ruling rely upon the step transaction doctrine by name, his holding is predicated upon his finding of "a single integrated transaction, a divisive reorganization." In neither
Under the step transaction doctrine, "a series of formally separate steps may be amalgamated and treated as a single transaction if they are in substance integrated, interdependent, and focused toward a particular end result." See B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 14.51, p. 14-175 (4th ed. 1979). The doctrine "is a particular manifestation of the more general tax law principle that purely formal distinctions cannot obscure the substance of a transaction."
Respondent's treatment ignores the economic realities of the transaction. To treat petitioner as having relinquished during the year before the Court a "substantial interest" as contemplated1989 U.S. Tax Ct. LEXIS 80">*93 by
Our opinion in
None of the steps in this transaction were meaningless or unnecessary. Indeed, respondent does not seriously dispute that the reorganization was undertaken for valid business reasons. Rather, the transaction before us is a textbook "D" reorganization to which respondent gave his seal of approval in the letter ruling of September 30, 1975. Both the transfer in the year before the Court and the distribution in a later year were critical to achieve the desired result. However, the distribution to the shareholders of the stock of the subsidiaries was not essential to separation of the three components of petitioner's business. The incorporation of two of the businesses as subsidiaries of petitioner could stand separately. That step was not dependent upon completion of the second step as the sequence1989 U.S. Tax Ct. LEXIS 80">*95 of the events demonstrates. We need not speculate upon the course of action which petitioner might have taken, had either of the requisite approvals by respondent and the SEC not been received. Suffice it to say that the parent-subsidiary form of doing business where multiple businesses are operated by the same interests is not unusual.
Other courts have recognized that the step transaction doctrine is not appropriate in every transaction that takes place in one or more steps. "Useful as the step transaction doctrine may be in the interpretation of equivocal contracts and ambiguous events, it cannot generate events which never took place just so an additional tax liability might be asserted."
1. The amount of the claimed overpayment is not apparent from either the petition or petitioner's brief. Since there is only one issue left for resolution, we leave it to the parties to determine the amount of the overpayment in their Rule 155 computations.↩
2. All section references are to the Internal Revenue Code of 1954 as amended and in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩
3. At petitioner's request, the IRS amended the ruling by letter dated Oct. 31, 1975. The substance of the ruling remained unchanged.↩
4. A reorganization is a "D" reorganization if it meets the requirements of
a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356.↩