TURNBOW v. COMMISSIONER
Legal provision: Internal Revenue Code
Argument of Francis N. Marshall
Chief Justice Earl Warren: Number 60, Grover D. Turnbow et al., Petitioners, versus Commissioner of Internal Revenue.
Mr. Marshall --
Mr. Francis N. Marshall: Mr. Chief Justice --
Chief Justice Earl Warren: -- you may proceed with your argument.
Mr. Francis N. Marshall: -- and may it please the Court.
This case involves the interpretation of Section 112 (c) (1) of the Internal Revenue Code of 1939, the so-called “boot” provision limiting recognition of taxable gains.
And also, by a parallel interpretation, it involves the interpretation of Section 112 (e) of that same Code which precludes recognition of tax losses in boot situations.
These are the facts.
The taxpayer, Turnbow owned all the stock comprising 5,000 shares of non-voting common stock of International Dairy Supply Company, a Nevada Corporation engaged in the business of dehydrating milk, shipping it abroad, reconstituting it as fluid milk, chocolate milk, and the like and supplying it in foreign countries to the United States Armed Forces in those countries.
Foremost Dairy Company, a New York Corporation was engaged in distributing milk and dairy products in this country.
These parties entered in the negotiations culminating in a so-called a mandatory agreement.
Under these terms, Turnbow exchanged or transferred all of the voting stock of supply to Foremost in exchange for 82,375 shares of the voting stocks of Foremost plus $3 million cash.
Supply was then to continue in business as an operating subsidiary of Foremost.
It was not to make any distribution to shareholders either under the plan or otherwise.
There were other provisions that made extensive changes in the management of the two companies.
The number of directors of supply was to be changed to six, so that Turnbow could maintain three directors, and Foremost could elect three directors.
An executive committee of three was created, two of them to be nominated by Foremost.
Turnbow was to be President and General Manager of Supply, while the President of Foremost was to be Vice-President of Supply and Chairman of its executive committee.
Turnbow was the -- a Director of Foremost and to have the right to nominate to other directors of Foremost.
Turnbow was to be Chairman of Foremost's Executive Committee.
Foremost's business was to be divided into two divisions, an Eastern Division and a Western and International Division.
The President of Foremost was to be General Manager of the Eastern Division and Turnbow was to be General Manager of the Western and International Division.
The terms of this mandatory agreement were carried out.
Now, the mere recital of these facts demonstrates several things.
First, there was a very real business purpose in the transaction.
There was a real reorganization of both companies in the corporate sense although not in the Revenue Code definitional sense as I shall come to in a moment.
Justice Charles E. Whittaker: Do you concede that that is so, that there is no reorganization in the Internal Revenue sense.
Mr. Francis N. Marshall: Yes.
That is true.
It does not meet the definition of the reorganization in the Internal Revenue Code.
No party has ever so contended and no court in the case has ever so held.
Secondly, these facts demonstrate that there was full continuity of the business enterprise.
And third, Turnbow continued to have a very substantial equity interest or state in that enterprise.
Turnbow, for the taxable year in question, reported the amount of cash received, $3 million plus the expenses of the transaction as capital gain and he paid his tax thereon.
The Commissioner determined that the capital gain to be recognized for tax purposes was the sum of the cash plus the expenses, plus the difference between the value of the Foremost stock at the time of the exchange and Turnbow's cost of the supply stock which he transferred.
Turnbow petitioned at the Tax Court for redetermination.
The Tax Court held that the recognized gain was limited to the cash boot under Section 112 (c) (1) declaring that no reason appeared for departing from its long established interpretation of that Section.
The Court of Appeals for the Ninth Circuit reversed holding for the Commissioner and this Court granted certiorari in view of the conflict of decisions with that of the Court of Appeals for the Seventh Circuit in Howard versus the Commissioner of Internal Revenue decided in 1956 which accorded with the decision of the Tax Court in the case Bonham.
Section 112 (c) (1), fits into an easily-understood tax patent.
Generally, gains and losses from sales or exchanges are recognized, that is made subject to appropriate tax treatment, at the time of the transaction under Section 112 (a) of the Internal Revenue Code of 1939 and its predecessors and successors, but the Congress made exceptions in the subsection immediately following, certain exchanges solely in kind to use the statutory phrase wherein inappropriate for immediate tax effect, that is the gains and losses therefore were not recognized as provided in Section 112 (b).
But this did not mean of course that the exchanges were tax free or that the participants escaped taxation, the tax effects were merely postponed until the taxpayer made a more radical change of his property ownership.
Until then, he merely held a paper profit or a paper loss, the same as though he continued to hold his former property either appreciated in value or depreciated in value as the case might be.
The next three subsections of Section 112 dealt with exchanges not solely in kind.
That is those which would be “solely” in kind types of exchanges, if it were not for the fact that money or other property that is other than the kinds described in Section 112 (b) and commonly called boot were also received.
Section 112 (c) (1) provided that gain in such a transaction should be recognized but not in excess of the amount of the boot.
At the same time, Section 112 (e) provided that loss in such a transaction should not be recognized for the obvious and expressed reason that otherwise, it would be too easy simply by adding a dollar to an exchange or superficial exchange that is one which left the taxpayer for all practical purposes still holding the same investment in the enterprise, to transform paper loss into a tax loss.
Parenthetically, I might say here that this couldn't work in the opposite direction under Section 112 (c) (1).
Since -- if money or other boot has added, any gain would always be immediately taxed to the full extent of the added boot.
The controversy here is between what appears to be the natural and literal reading of Section 112 (c) (1), one which the Tax Court has applied and declared for many years, and which is in the fullest harmony with the legislative policies in the pattern of the tax law on one end, and a strained and unnatural reading implicated by the Commissioner which is out of step for these things, and in particular opens up a large “loophole” for the taking of paper losses as tax losses.
In short, in this case, the Commissioner seems to be beating of the little fire or reflection of a fire in front of him, or he's starting a large fire in his rear.
The words of the statute, Section 112 (c) (1) are simple enough.
As applicable to this case, it says, if an exchange would be within the provisions of subsection (b) (3) as it relates to this exchange, now these subsections are mentioned.
If it were not for the fact that, the property received in exchange consist not only of property permitted by such paragraph to be received without recognition of gain, but also of other property or money, then the gains of the recipient shall be recognized within an amount not in excess of such money.
And subsection (e), uses parallel, identical language, really.
It says, “If an exchange would be within the provisions of subsections (b) (1) through (5), and here (b) (3), or with -- of this Section, if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph to be received without the recognition of gain or loss, but also other property or money, then no loss from the exchange shall be recognized.”
Now this language directs us to Section 112 (b) (3) which says, “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 a stock or securities in such corporation or in another corporation a party to the reorganization.”
And reorganization is applicable here on this “would-be-within” basis.
It's defined in Section 112 (g) (1) (B) and again using “solely”.
And Section 112 (g) (1) (B) starts as follows, the term “reorganization” means (a) a statutory merger or consolidation, (b) the acquisition by one corporation in exchange solely for all or a part of its voting stock of at least 80% of the voting stock and at least 80% among the total number of shares of all other classes of stock of another corporation, or (c) the acquisition by one corporation in exchange solely for all of its voting stock and essentially all the properties of another corporation, and so forth.
And by the way, this lettering scheme (a), (b) and (c) has given rise to the practice of referring to various transactions as, (A) type of reorganizations, (B) type of reorganizations, (C) type reorganizations, and so forth, which will be a convenience in this case.
Justice John M. Harlan: This is a (B) type?
Mr. Francis N. Marshall: No sir, it is not a reorganization, but it is a “would-be” (B) type of reorganization --
Justice John M. Harlan: Or it “would-be” (B) type, yes.
Mr. Francis N. Marshall: -- if it weren't for the cash.
Justice John M. Harlan: But (B) is the relevant paragraph --
Mr. Francis N. Marshall: Yes sir.
Justice John M. Harlan: -- in this set.
Mr. Francis N. Marshall: Now one thing, it's beyond any possibility of dispute in this case.
If Turnbow had not received any cash, the exchange would have been solely for stock or securities as specified in Section 112 (b) (3).
At least 80%, in fact, 100% of the stock of supply would have or was transferred and solely voting stock of Foremost would have been received.
Therefore, the exchange would be within all the provisions of Section (b) (3) and none of the gain would be recognizable.
Justice Charles E. Whittaker: Would it be -- would it be planning -- maybe I'll just ask you for information now, 112 (b) (3) says, “No gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are,” and so forth.
Mr. Francis N. Marshall: Yes sir, because, if no cash has been received, then, solely voting stock would have been received and it would meet the definitional requirements of reorganization in the tax code.
So it would have met all the requirements and there can be no possible doubt of that.
If there had been no cash, it would've met all the requirements of solely stock or securities, solely voting stock and reorganization because they all hang together under those circumstances.
Justice Potter Stewart: And Foremost would've been a party to reorganization.
Mr. Francis N. Marshall: Yes, that is true.
It would've been a party of the reorganization in the tax definitional sense if that fact -- if that had been the actual fact.
No cash received.
Justice Felix Frankfurter: Is there no problem of the amount of stock received?
Mr. Francis N. Marshall: There would be a problem of the amount of stock received Mr. Justice Frankfurter, I think if the amount of stock received were such a sham or if there was a subterfuge or if the Court could find that there was no real business purpose or corporate purpose.
But where the amount of stocks received is substantial and gives Turnbow a substantial interest in the continuing enterprise, then I think we lose any problem with mathematics here.
We are simply to determine if he did have a substantial interest in this continuing enterprise --
Justice Felix Frankfurter: Did you answer Justice Harlan that this comes under (B)?
Mr. Francis N. Marshall: I beg your pardon sir.
Justice Felix Frankfurter: Did you answer Justice Harlan that this comes under (B)?
Mr. Francis N. Marshall: No sir.
I answered it that it does not come under B because of the cash, but it would come under B if the cash were not there.
Justice Felix Frankfurter: If it comes under (B), then -- then 80% comes into play, doesn't it?
Mr. Francis N. Marshall: Yes sir.
And 80% in fact, 100% of the stock of supply was transferred.
So, all --
Justice Felix Frankfurter: And you satisfied any of them in your point of view?
Mr. Francis N. Marshall: Yes.
That was satisfied anyhow.
In fact, we again come to this blunt fact that if it weren't for the cash, if no cash were received, then all of the requirements of (b) (3) would be satisfied and the exchange would be totally tax-deferred.
Justice Hugo L. Black: Be what?
Mr. Francis N. Marshall: Totally tax-deferred.
The Commissioner himself readily agrees that the “if not” language of Section 112 (c) (1) removes the effect “solely” or perhaps it's more accurate to say, hypothetically restores the “solely” as the word is expressed in (b) (3), but then he says, he can not retain this effect and hypothetically restore the “solely” imported into (b) (3) in the reference to reorganization.
In other words, where (b) (3) has three requirements, solely for stock or securities, in a party or reorganization which in this case means -- in this context would mean solely for voting stock and a plan of reorganization which in this context again would mean solely for voting stock.
The Commissioner freely admits that the “if not” hypothesis operates to restore the “solely” in the first one, but then he says, it denies that it restores the “solely” which is repeated in the other two.
But still, I say, we were faced with the fact that if it were not for the cash, if no cash were received, then all the “solely's” are satisfied.
The Commissioner arrives at this position by a curiously inverted reasoning and it's all more strange because in trying to cage this mouse, he's letting all the animals escape under Section (e).
The point he is trying to reach is the transactions which “would-be” (B) type or (C) type reorganizations but for cash added can never come under Section 112 (c) (1).
And this is the way he goes about it, he said -- he says, let's first lay to one side all these -- if it “would-be” if not hypothetical business and see what we have in fact.
There was cash boot received hence, there was no reorganization, hence, there was no property permitted to be received without recognition of gain, hence, (c) (1) can apply.
But this reasoning doesn't stand the test.
For example, consider a statutory merger, an (A) type reorganization which often includes cash as part of the consideration along with stock, the Commissioner concedes that such a transaction comes within -- comes in for a limited recognition of gain under Section 112 (c) (1), that is if the stockholder taxpayer would be a subject to recognition of gain but only to the extent of the cash.
But suppose we now apply his reasoning to that situation as he applies it in this case, and by the way, this is a course of reasoning that appears to have been developed for the first time in the brief filed in Court.
He compartmentalizes the two categories of property mentioned in (c) (1) without regard for each other.
That is first, property to be permitted to be received -- a property permitted by Section (b) (3) to be received without recognition of gain, and second, cash.
Then he says, without excluding the cash, see if there is property permitted by (b) (3) to be received without recognition of gain.
Now in our merger situation -- in a merger situation I'm just postulating, there is stock plus cash.
So to find out if there is property permitted by (b) (3) to be received without recognition of gain, we turn to (b) (3) and that says, “If stock or securities are exchanged solely for stock or securities.”
So looking squarely at the cash, we cannot find that stock or securities are exchanged solely for the stock or securities.
So the first compartment or category in Section (c) (1) will never be filled and (c) (1) can never be fulfilled.
Logically, the Commissioner's step-by-step reasoning was compartmentalization and it operates equally at all as always.
This shows to me that this compartmentation method is all wrong.
The two categories do have regard for each other.
The cash doesn't jump out of the exchange to get rid of part to the effect of “solely” and then jump right in -- and jump right back in again so as to bring “solely” back to life.
This illustrates to our way of thinking artificial and self-contradictory nature of this argument.
Of course, in fact, “solely” doesn't appear in (c) (1) and neither does “reorganization.”
The actual status inherent in those words is not part of (c) (1) which hypothesizes a contrary status by the “if not.”
All along, Congress has made it clear that as to a stock for stock exchange, or a merger, or substantially all the corporate assets for stock, or recapitalization, when the business enterprise is continued and when to the extent that the investors' interest in the enterprise is continued, in other words, Foremost property loss is rather a paper profit or loss in the continuing business enterprise than a real property loss in the terminal transaction.
Then, in order not to hamper legitimate business adjustments, Congress is satisfied to defer present tax effects and require a tax accounting later when the taxpayer has made some sort of a terminal transaction.
But, when cash or other property outside the continuing enterprises added to the consideration, Congress will immediately tax any gain to the extent of the boot.
But not to any greater extent lest it (Inaudible) the policy stated just before.
The laws of the legislative policies and the congressional pattern, a longstanding and clearly understood by the Congress, and they are fully satisfied in this case by taxing Turnbow on his gain to the full extent of the cash received as has been done in deferring the tax as to a stock interest in the enterprise until he has made some final disposition of it as the Tax Court held.
When Congress has made it clear that when a shareholder exchanges his voting stock in one corporation or voting stock in another and there are in fact an honest business purpose, a continuation of the business enterprise and a continuing substantial interest of the shareholder in that enterprise, the time is not then appropriate for a tax accounting, the tax reckoning on the stock received in the transaction.
And when as I say Congress has made that clear, then it is difficult to see how that time is anymore appropriate as to the stock simply because the shareholder has received a dollar in addition and pays his tax on the dollar immediately.
That is what Section 112 (c) (1) takes care of and that is the case here.
Justice John M. Harlan: Mr. Marshall.
Is the Commissioner's present position been -- does it represent a change in the position that he formerly took?
Mr. Francis N. Marshall: I believe so Mr. Justice Harlan, because in the Howard case for example, the Commissioner was apparently urging that Section 112 (c) (1) apply, so as to tax -- to lay a tax on the amount of cash and a promise to pay preferred stock in that case, and the Commissioner was on the other side of that case.
Now that case turned also upon the question of whether the transactions preferred by stockholders exchange their stock, should all be taken together or whether they were separable.
Nevertheless, the Commissioner was apparently advocating the application of (c) (1) in that case.
More than that, however, the fact is so important that the Tax Court ever since 1934, the Tax Court of 16 expert tax judges has been applying this interpretation as natural interpretation of Section 112 (c) (1) and is applied originally in the Bruce case, and the Bonham case, and the Love case, that's all going on without change.
The taxpayer -- the Tax Court would never have any division of opinion and never deviated from that method of interpretation which is simply as the taxpayer says in this case, eliminate the cash and then see what you have here.
Justice John M. Harlan: Those are cases cited at the -- in the note at the bottom of page 11 of your brief, are they?
Mr. Francis N. Marshall: Yes sir.
The opening brief and they're also dealt within our reply brief.
So in the light of that long standing rule of interpretation of the Tax Court which apparently has been the decided law until for the first time, our court went the other way, when the Ninth Circuit Court reversed the Tax Court in this case.
It is difficult to see how there hasn't been some really extreme change of the view of the law.
Justice John M. Harlan: Is that the first -- is the Ninth Circuit, first time, has been a deviation in the courts, isn't that what you're arguing?
Mr. Francis N. Marshall: No I understand that, I've never been able to find any other deviation in the court.
Justice Charles E. Whittaker: Mr. Marshall, the words of how you described (c) (1) pretty clearly fits your situation, but it still leaves me doubtful about the meaning of this word “reorganization” in the 112 (b) (3), through, if -- as how you developed the concept, an exchange would be within the provisions of (b) (3) if it were not for the fact, that property received in exchange consisted not only of the stock, but also of money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the money, yet this seemed to contem -- it contemplates that they're, in truth, a reorganization?
Mr. Francis N. Marshall: No sir.
It does not.
The whole pattern of this Section 112 (c) (1) is a hypothetical contrary to facts basis and that's the way it has always been applied and looked at.
It is the very idea -- it would be -- if not -- if it were not for the fact that implies a contrary to facts, so we don't look at the actual effect, we look at the situation as it would be if you've eliminated the cash.
And that has been the whole pattern ever since these provisions were put in the law back in 1924 and 1923.
Now, may I -- may I just add to that this very fact, if it weren't for the fact that cash was received, then again, we get to the situation where all the requirements including reorganization, including solely for voting stock are met.
They're all there.
So, you have your basic pattern and then when you have your cash added, the Congress simply says, well, “We aren't going to -- we aren't going to let the taxpayers escape taxation on any gain to the extent of the boot, but we're still going to defer his tax to the extent of the stock in this bona fide business readjustments until he makes some more terminal disposition of it.”
It still gets back to the undoubted fact that without the cash, all of the requirements of these three are met.
All the “solely's” are met.
Reorganization is met.
It would then be a reorganization, it would be within the terms of Section 112 (b) (3), and it is not simply because there is cash added but as to the cash, the taxpayer has been taxed, he's paid his tax and that part of it is closed.
I would like to reserve the rest of my time for the reply if the Court please.
Chief Justice Earl Warren: You may Mr. Marshall.
Argument of Wayne G. Barnett
Mr. Wayne G. Barnett: Mr. Chief Justice, may it please the Court.
I'd first like to correct a couple of matters as to Mr. Justice Harlan's question about our prior position.
The Government has never maintained any other position with the position we are maintaining now.
We do not maintain the opposite position in Howard, as to prior decisions, the long line of Tax Court decisions to which the petitioner refers, I think we found to be nonexistent.
Just through, in the Bonham case decided in 1936, under the Revenue Act of 1928, there is a reference and statement of the question, assuming the absence of the cash before going to the reorganization definition.
But the reorganization definition under the 1928 Act did not contain the solely for voting stock requirement and I hope to show that's the very reason that requirement is added was to prevent qualification of this very kind of transaction.
Justice William J. Brennan: Mr. Barnett, this may not be too relevant, but I'm just curious.
In terms of the revenue whichever way this comes out, does it matter too much?
Mr. Wayne G. Barnett: It matters a great deal, primarily as I will try to show in the interaction with the basis provisions.
I'll have to develop something before I get to that, but I think I could (Inaudible).
I would like to start just by trying to simplify and clarify the structure of the reorganization provisions, see what the definition is there for, and what it is meant, what function it's meant to serve.
Section 112 (g) (1) is purely definitional.
It simply says which transactions are reorganizations and which are not.
It doesn't prescribe the consequences, the consequences that qualify as reorganization are specified elsewhere and they are two in number.
The primary one is that described by Section 112 (b) (3) and (c) (1).
That is, if there is reorganization, then exchanges in pursuant of the -- pursuance of the plan of reorganization are tax-free except to the extent of boot, i.e. the gains or losses not recognized except for any boot received.
I might note that the result that the petitioners contend for here is precisely the result that would obtain if it were reorganizations.
So this argument means that not being a reorganization has no effect upon the recognition for gain.
The other consequences of being a reorganization is that prescribed in the basis provisions, the provisions governing the basis of property for purposes of depreciation and determining gain or loss on subsequent sale.
Section 113 (a) (7) provides that if a corporation acquires property, here that would be the Foremost Corporation, the acquiring corporation, acquires property in a reorganization.
It does not get a new cost basis for the property unless it rather takeover the basis that the property had in the hands of the transferor.
Now, those are the only two consequences for reorganizations.
They are specified in the 1939 Code, that is nonrecognition of gain to the transferor and carryover the basis to the transferee.
Now, from those consequences, I think the basic notion of what a reorganization is becomes clear.
The definition simply describe transactions on which Congress has deemed there is not a sufficient change in the nature of the underlying property and the interest in it to justify a reckoning up of gain or loss to the transferor or the creation of the new basis to the transferee.
The enterprise ought to continue on and the tax status quo should be maintained.
But what that means is that the definition of a reorganization has as its very purpose the specification of the kinds of transactions in which the exchanges would be subject to the nonrecognition provision.
That's its only purpose in as much as the basis carryover is really a corollary to the nonrecognition of gain.
Now, in this case, as I say, the word “reorganization,” the gain would be taxable only to the extent of the cash which is the result to which the petitioner contends.
But it's admitted that there is not a reorganization in this case because he failed to satisfy the solely for voting stock requirement in the definition of a reorganization, the “would-be” definition.
But he says, it makes no difference, the result is the same as though that requirement were not there.
Now I think a complete answer is that his argument destroys any purpose to solely for voting stock requirement.
It has no consonance.
Now, I shouldn't say that it destroys it because his argument, under his argument, while the failure to satisfy the solely for voting stock requirement doesn't have any effect upon his recognition of gain.
It does control the basis consequence to the transferee in this case, because there was in fact, no reorganization.
The basis carryover provisions does not apply and Foremost gets instead of the petitioner's low basis for the supply stock that it had, a stepped-up fair market value basis of the stock.
Justice William J. Brennan: Is that -- is that established or is that --
Mr. Wayne G. Barnett: I think there's no question about it.
Section 113 (a) (7) says the basis of property shall be cost --
Justice William J. Brennan: I know, what I meant was the federal -- this will adjudicate this consequence on this?
Mr. Wayne G. Barnett: The most -- a large number of the reorganization cases, Helvering v. Southwest Consolidated as a matter of fact is a basis case.
And it goes on the question whether or not it is a reorganization.
A lot of the litigation has been over the basis consequence rather than the nonrecognition of gain consequence and that's always implicit in those cases.
Now, I would like to emphasize what that means.
Consider a corporation that has assets, business assets with the high value but a low basis.
It transfers those assets to a new corporation.
If it does so, solely for voting stock, it is a (C) reorganization.
The transferor corporation recognizes no gain but also, the transferee corporation has to takeover the low basis.
Now, on the petitioner's view, all the parties need to do is add a little cash to the consideration for the assets and the results would be that the transferor corporation still doesn't recognize the gain except for the nominal amount of cash itself, but the transferee corporation, it's a brand new stepped-up fair market value basis for appreciation.
And it's that consequence of petitioner's argument that makes the case so important.
Justice William J. Brennan: For depreciation only or for --
Mr. Wayne G. Barnett: And also on the case of stock would be only for a purpose of subsequent sale and it's that consequence that makes the question so important.
Justice William J. Brennan: (Inaudible) that the new basis would be significant appreciation and ultimate sale?
Mr. Wayne G. Barnett: Ultimately, I think that would probably be right.
The -- now, I think simply on the face of the statute, the consequences of the argument upon the solely for voting stock requirement even there was no -- no understandable purpose at all, shows the policy in petitioner's argument.
I would like to --
Justice Potter Stewart: Because the new basis wouldn't always be a higher basis?
Mr. Wayne G. Barnett: That is correct, in a case in which the property has a high basis and a low value, not the -- in that case, the parties would not put in the nominal cash and make it qualified as a reorganization.
Now, I would like briefly to say that the history of the solely for voting stock requirement of the (B) definition, it was added in the Revenue Act of 1934.
Before the Revenue Act of 1934, the definition of assets for stock acquisition reorganization is open-ended.
Literally, it only requires that the acquiring corporation acquire substantially all the properties of the other corporation or the majority of the stock.
It did not say anything about what was given in exchange.
But the Treasury argues that the underlying presuppositions to reorganization definitions require that the transaction partake of the nature of a merger in consolidation, and where a large part of the consideration was in form of cash or short-term notes.
It did not have that nature and should not be held that the reorganization was more like a sale.
Those are the terms in which the argument is cast.
That argument proved only partly successful.
Chief Justice Earl Warren: We'll recess now Mr. Barnett.
Argument of Wayne G. Barnett
Chief Justice Earl Warren: Grover D. Turnbow et al., Petitioner, versus Commissioner of Internal Revenue.
Mr. Barnett you may continue with your argument.
Mr. Wayne G. Barnett: Mr. Chief Justice, may it please the Court.
Yesterday, I tried to show that the very function of the reorganization definition was to trigger the operation of the nonrecognition provisions.
And as to the petitioner's argument, the boot provision permits the nonrecognition of gain whether or not there's reorganization, would deprive the definitions of the only function they have.
I'd like to turn the now to what started yesterday to the history of the solely for voting stock limitation of the B and C definitions.
Those were added in 1934.
Before that, the definitions were as they are set forth at page 61 of our brief and you will see that, what is now the A, B and C definitions were lumped together in a single clause, that defined as a reorganization, a merger or consolidation and then (including the acquisition by one corporation of at least a majority of the stock or substantially all the assets of another).
Now that parenthetical clause did not impose any limitation upon the property given in exchange for the acquisition.
However, because it modified the merger or consolidation, the Government argued that it was meant to include only those transactions that were in practical effect essentially of the same nature as a merger or consolidation, and therefore, if any substantial part of the consideration was cash or short-term notes instead of the continuing interest, that was in practical effect a sale rather than a merger or consolidation and not covered.
Now, that argument was successful only in part and in a line of cases which culminated in a group of decisions by this Court in 296 U.S. the leading one which is Helvering against Minnesota Tea.
It was held that it was sufficient to qualify as reorganization if a substantial and material part of the consideration was voting stock or common stock, a continuing interest of the enterprise, even though the rest of the consideration in the very large part was cash and in fact, the Minnesota Tea that was held to be a reorganization even though almost 50% of the consideration was cash and therefore, the consequence was that the gain was recognizable only to the extent of the cash rather than as the Government argued the whole gain being recognized.
Now, this case, the transaction in this case is a blood-brother to Minnesota, the transaction in Minnesota Tea.
It's in fact a little more extreme because here, over 70% of the consideration was cash.
Nevertheless, under the pre-1934 Act under the rationale of Minnesota Tea, the transaction here would have qualified as a reorganization with the consequence that the gain would have been recognized only to the extent of the cash.
Now, it was against the background of that litigation and the asserted sale reorganization dichotomy that the 1934 Act was inactive.
The House Committee about the prude of decisions holding the transactions to be reorganizations where no money passes said that when it called the stoop lawyers had been successful in arranging what were in fact sales in the form of reorganizations and to present that, it recommended eliminating entirely whether or not the B and C definitions and restricting the statute to statutory mergers and consolidations.
The Senate Committee, although agreeing with the purposes of the House and the need to prevent sales from qualifying as reorganizations, pointed out that a lot of states did not have statutory provisions permitting mergers and consolidations and that no states, it was necessary to have some other mechanism to achieve necessary business readjustments without the incident attacks.
Accordingly, to permit that while at the same time preventing sales from qualifying as reorganizations, it recommended putting back the B and C definitions, but limiting them to transactions in exchange solely for voting stock.
In the Senate Committee's view, if it was solely for voting stock, it should be like in the mergers and consolidations.
If, however, there was anything but voting stock, it should be classified as a sale and for the very purpose of requiring that the entire gain not simply the cash which is always taxable to require the entire gain be taxable.
Now, this transaction which would've been a reorganization before the 1934 Act and therefore, taxable only to the extent (Inaudible), admittedly which it has to admit is no longer a reorganization because of that change.
The anomaly is that he goes on to argue that it makes no difference and that his gain is taxable precisely as it would've been before Congress added that limitation and he argues that, even though this transaction in an aggravated form is the very kind of transaction, the Congress, both the House and Senate agree to not be entire to the benefits of nonrecognition even in part.
Now, there's also one subsequent that -- of legislative history after the years in question here that I would like to call the Court's attention.
Under the 1939 Code, Assets and Acquisitions, noted under the C definition, had to be solely for voting stock to qualify as a reorganization.
Justice John M. Harlan: (Inaudible)
Mr. Wayne G. Barnett: When C would cover?
I mean B or C definitions?
Justice John M. Harlan: (Inaudible)
Mr. Wayne G. Barnett: It would cover -- it would've covered this case if all that he had received have been voting stock and that's all that it does cover.
If your question is directed towards whether there can ever be boot in a B or C reorganization, I would like to say that isn't open question.
There are several questions and interpretation left on that issue.
The Howard case itself involved the transaction that quite arguably was a reorganization, you will know that B requires only that 80%, at least 80% of the stock of the acquired corporation be acquired.
It's therefore arguable that if you acquire at least 80% solely for voting stock, then even though you pay cash for the rest, it would still be a B reorganization.
That was the fact in Howard case.
There's 81% of the stock was acquired for voting stock and 19% for cash.
The Seventh Circuit, in fact, held that the cash aided the sitting minority, prevented the B reorganization.
That's the only decision -- that is not a decision, a reduction I believe, but that is really still an open question and I think it's a very good argument and likely to have argument that if you -- if 80% of the stock is acquired for voting stock, the fact that an additional -- a necessarily additional amount of stock is acquired for cash whatnot disqualified.
Justice Felix Frankfurter: What do you mean with only?
Mr. Wayne G. Barnett: Well, the question is what has to be acquired solely for voting stock?
Since, all you have to acquire to be a reorganization is 80% of the stock of the acquired corporation.
If you acquire that much solely for voting stock, the argument is, why should it make any difference that you go on to acquire some additional stock for cash?
Why should that disqualify what otherwise would've (Voice Overlap)
Justice Felix Frankfurter: What is the function of (Voice Overlap)?
Mr. Wayne G. Barnett: I'm not arguing that.
I'm only saying that there is still an open question.
It has never been precisely resolved in the assets acquisition, this Court's decision in Southwest Consolidated in 315 U.S. seems pretty conclusively to mean to say that there can't be anything at all besides voting stock.
But those definitions were changed after the boot provision got to its present form.
The boot reasons that I'm willing to show is simply a standard mechanical rule and the reorganization definitions are the instrument of policy.
It's by them that the Congress has been time to time changed its mind about what kinds of transactions ought to qualify for nonrecognition even in part.
Now I think the history that if it's foretold will answer.
The requirement and assets acquisition of the exchange -- the acquisition would be solely for voting stock was found to be too harsh.
In the 1954 Code it was relaxed.
The C definition in the 1954 Code requires only that at least 80% of the consideration be voting stock and the addition -- and the rest of the consideration up to 20% can be cash or other property and still qualify as reorganization.
I would like to give you, read to you the Senate Committee's explanation of the reason for that change.
Unfortunately, this isn't cited in our brief.
I have only discovered it and so I would like to read to you the actual text.
The Senate Committee said this, “Under present law,” that's 1939 Code, “if one corporation acquires substantially all the assets of another, the acquisition must be made entirely for voting stock or the transaction will not be subject to the nonrecognition rules to any extent.”
That is to say, the committee reports says that a failure to meet solely for voting stock requirement, doesn't simply bar characterization as reorganization in the abstract.
It bars the applications of the nonrecognition rules that is (c) (1), the boot provision to any extent and it goes on to say that the reason making the change is so that you can't have some cash and still be entitled to partial recognition.
The statement by the Senate Committee is a direct and explicit answer to the very argument made by the petitioner here.
Justice John M. Harlan: (Inaudible)
Mr. Wayne G. Barnett: 1954 Code.
It's the Senate Report 1622, the 83rd Congress Second Session, page 263.
Now, having shown, I hope that the petitioner's construction of the boot provision will make a shambles of the reorganization definitions and the functions they serve.
I would now like to turn to the boot provision itself to show that the interpretation producing those results is in fact not even colorable.
The -- we have to start with (b) (3) because we are talking about the interaction of (c) (1) with (b) (3).
Section (b) (3) is set forth in our brief at page 15.
It says, that no gain or loss shall be recognized if stock or securities in a party to a reorganization are exchanged pursuant to the plan of reorganization solely for stock or securities in another party to the reorganization.
Now, as you point out on page, the following page, page 16, there are in fact four requirements to be under (b) (3); (b) (3) is the basic nonrecognition provision.
The first requirement is that the exchange be pursuant to a reorganization.
The second is that the taxpayer, the stockholder whose exchange is involved, transfers stock or securities in the party through reorganization.
The third requirement is that he receive stock or securities in a party to the reorganization.
And the forth requirement is that he receive solely such stock or securities.
That is to say, if the first three requirements are all satisfied as they may be in many types of reorganization, there is a reorganization, the exchange of stock or securities in a party for reorganization and he receives stock or securities in a party to reorganization, even though, those are satisfied, if he receives not only the property permitted by that section to be received which is stock in a party through reorganization, but also other property, he does not -- his exchange is not qualify because that fourth requirement that he receive solely qualifying property.
Now, with all that, I would like to turn to the boot provision itself, Section (c) (1), and that is set forth on page 22 of our brief.
It's a very -- a difficult section to read.
It has a lot of negatives and one has to read it very carefully.
What it says is, if an exchange would be within (b) (3), if it were not for the fact that the property received in exchange consists not only of property permitted by (b) (3) to be received without the recognition of gain, but also of other property.
Then gain is recognized only to the extent of the other property.
Now what I mean to show is that that is expressly in reference to a failure to satisfy the fourth requirement as I set them out, the basic nonrecognition provision.
Now I think that can be seen more clearly from this schematic restatement of (c) (1) at the bottom of page 22.
We have set it forth there and attempt to separate the various steps.
And what it sets effectively, this is our recasting of it, so you can see the steps, if in an exchange there is received both one property permitted by (b) (3) to be received without the recognition of gain and to other property, and the next step, if the exchange would be within (b) (3) if only the permitted property had been received, the gain is taxed to the extent of the other property.
Now, the first step before you reach the hypothetical question, the ‘would be' question, is to satisfy that requirement that some of the property received be property permitted by (b) (3) to be received without the recognition of gain.
You have to have some property independently qualifying under (b) (3) before you reach (c) (1), it says that expressly.
Now the only property permitted by (b) (3) to be received without the recognition of gain is stock or securities in a party to a reorganization.
Here, there was no reorganization, Foremost is not a party to reorganization and the stock in Foremost was not stock in a party to a reorganization.
The taxpayer here received nothing qualifying under (b) (3).
None of his property was property permitted by (b) (3) to be received without the recognition of gain.
It was all other property.
Everything he got was boot in the dichotomy established by (c) (1).
You'll never reach the hypothetical question whether if he'd received only the permitted property, it would've been under (b) (3).
I think if we follow through the statute, I realize it's a very difficult thing to follow, if you follow through this page, I think you will find that it is impossible to read the statute the way the petitioner reads it.
There's one other independent objection in the petitioner's reading which I briefly like to suggest whether it's the reorganization definitions themselves talk about the whole transaction which normally involves a lot of exchanges.
The (b) (3) and (c) (1) talk about the individual exchanges pursuant to the whole plan and it deals specifically with each individual exchange separately.
Therefore, (c) (1) when it talks about the property received in exchange is talking only about the property received in exchange by the single stockholder in his exchange.
It doesn't say a word about what was received by other stockholders in other exchanges.
Now, in most of these cases, this case is atypical because there's only one stockholder, in most cases there are a lot stockholders and to any boot, a lot of stockholders receive part of it if there's any cash.
And that was true in the Howard case, in the Howard case, the taxpayer, Howard, had in fact himself received only voting stock, he didn't receive any cash.
Another stockholder had received cash, and the Court of Appeals in Howard said, that under (c) (1), he could assume a way, the cash received by the other stockholder in order hypothetically to qualify as a reorganization and that is an impossible reading of (c) (1).
It talks about, only about, what the individual stockholder receives in his exchange.
And you just cannot read it to permit you to assume that other stockholders didn't receive something in order, hypothetically, to qualify as a reorganization.
Justice John M. Harlan: (Inaudible)
Mr. Wayne G. Barnett: The last argument I think, is a red herring.
First of all, it's always been true that by not being a reorganization, you can avoid the nonrecognition provisions and take loss and there's nothing to suggest that Congress has ever attempted to avoid that consequence.
As a practical matter, the answer that is suggested by Justice Stewart yesterday, if you avoid being in a reorganization in order to take a loss, the acquiring corporation gets a reduced basis.
In a loss situation, you have a high basis and the acquiring corporation would normally like to take over your high basis for depreciation purposes in a C type of reorganization.
If you avoid qualifying as a reorganization so that you take a loss, the consequence is that the acquiring corporation has to take a mark-down basis.
So as a practical matter, you always want it to be in the loss situation, a reorganization.
Another answer is that the loss situation usually occurs in insolvency type reorganizations and insolvency reorganizations are governed by other provisions (b) (10) and Section (l).
I would like to say -- well I think what I've said is in summary if I may, what I've said is enough to answer the argument.
There are a lot of other things wrong with the argument which we've tried to spell out in the brief.
Chief Justice Earl Warren: Mr. Marshall.
Argument of Francis N. Marshall
Mr. Francis N. Marshall: In this very few minutes, may it please the Court, I should like to make these two points.
The Solicitor General has remarked this morning that in the 1934 Committee reports, both House and Senate agreed that there shouldn't be any entitlement to nonrecognition of gain even in part of this kind of transaction.
Reading the House and Senate Committee reports, they make no reference to the impart situations whatsoever that I can find.
There was reference to the situations where a total nonrecognition of gain or loss was involved and that is all.
The -- there was never any reference to the boot provisions which presumably acted as they always have by taking care of any boot added -- by nonrecognition or deferment of the gain or loss, whatever it might be until there was a more terminal transaction.
On this question of the fact -- on the revenue which Mr. Justice Brennan asked yesterday and which the Solicitor General answered by referring to the base provisions, there are several answers.
In the first place as to this type of transaction, it must be remembered that the Government gets all its tax.
Turnbow has already paid his tax on the $3 million in cash and as soon as he makes some terminal transaction affecting his stock interest in the continuing enterprise, then the Government will get its tax on any gain resulting there from.
Justice Charles E. Whittaker: What is the basis (Inaudible)
Mr. Francis N. Marshall: It is --
Justice Charles E. Whittaker: (Inaudible)
Mr. Francis N. Marshall: No, Mr. Justice Whittaker, it will not, it will be the cost basis of the shares which he transferred.
And therefore, all of his gain which is in Court at this moment in his stock interest in the continuing enterprise will be subject to tax as soon as he makes a more terminal disposition of his stock interest in the continuing enterprise.
Justice William J. Brennan: But Mr. Marshall I thought Mr. Barnett took the different position as to this.
Mr. Francis N. Marshall: I think not, Mr. Justice Brennan.
I think he is talking about the basis for the acquiring corporation which is an entirely different proposition and is not involved in this case at all.
Justice William J. Brennan: Well, you agree with him that the acquiring corporation does acquire different places for appreciation and so forth?
Mr. Francis N. Marshall: There may be a stepped up basis or a stepped down basis as the case may be.
In the South -- Helvering versus Southwest case for instance, there was a very greatly stepped down basis.
I think the -- the assets have gone from a cost basis of something like $9 million down to something like $700,000.
But in -- that is a different kind of a question because the problem that we have is the gain or the loss for the particular tax there transferor and that is what is covered in Section 112 (c) (1) and not anything else.
Also, it has been showed in our brief, that basis is not irretrievably with it.
That is the basis of the corporation.
It's not irretrievably wedded to the basis for the transferring shareholder which is the question here and the only question here.
And so far as that is concerned, there is no question because the shareholder retains his old basis for the property transferred, and all of his gain, ultimately a subject to tax when this (Inaudible) gain or paper profit has turned in to an actually realized profit as the case maybe or a loss.
Justice Charles E. Whittaker: (Inaudible)
Mr. Francis N. Marshall: That is another situation Mr. Justice Whittaker.
That is a problem that runs through the whole tax law and affects anybody and everybody and it affects of course a man who simply holds the same property, appreciated or depreciated as the case maybe or who holds an exchanged stock interest in the continuing enterprise which however doesn't change the actual interest in the enterprise anymore than in form.
Therefore, that is a side issue that runs through the whole tax law and doesn't affect this particular problem.
I think the answer really is that the matter always works in both directions so the effect on the revenue is up or down as the case maybe.
May I have just one moment please Mr. Chief Justice?
Chief Justice Earl Warren: One moment, yes.
Rebuttal of Wayne G. Barnett
Mr. Wayne G. Barnett: And that is to say that this question is not what Congress wrote in the basis provision, but what Congress wrote for this limited recognition.
We are in a limited recognition provision going back to 1924 and on that question, the Tax Court has always held at the same interpretation and it is declared as it is held in this the same interpretation.
Going back to 1934, Bruce, in 1936 Bonham, in 1939 Love, there was also a case in the Court of Appeals, First Seattle; all of those are mentioned in a footnote on page 11 in our brief.
And finally, in Bonham where the -- pardon me, in Turnbow in the Tax Court where the Court itself said, thus there has been a long standing and continuous construction of Section 112 (c) (1) and the corresponding section in the earlier revenue acts which has remained unchanged over the years in the face of several reenactments of the statutory provision.
And in the light of the Tax Court's own declaration without any division of opinion throughout all this years that that was an interpretation of Section 112 (c) (1) that comes as somewhat of a shock for the attorney, for the Government to say that these decisions were non-existent.
They did exist and the taxpayers had a right to rely upon them.
We submit that the judgment should be reversed.