Central Tablet Mfg. Co. v. United StatesAnnotate this Case
417 U.S. 673 (1974)
U.S. Supreme Court
Central Tablet Mfg. Co. v. United States, 417 U.S. 673 (1974)
Central Tablet Mfg. Co. v. United States
Argued March 25-26, 1974
Decided June 19, 1974
417 U.S. 673
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
When a fire destroys insured corporate property prior to the corporation's adoption of a complete plan of liquidation but the fire insurance proceeds are received within 12 months after the plan's adoption, the gain realized from the excess of such proceeds over the corporate taxpayer's adjusted income tax basis in the insured property must be recognized and taxed to the corporation, and is not entitled to nonrecognition under § 337(a) of the Internal Revenue Code of 1954, which provides, with certain exceptions, for nonrecognition of gain or loss from a corporation's "sale or exchange" of property that takes place during the 12-month period following the corporation's adoption of a plan for complete liquidation effectuated within that period. Pp. 417 U. S. 677-691.
(a) The involuntary conversion by fire, recognized as a "sale or exchange" under § 337(a), takes place when the fire occurs prior to the adoption of the liquidation plan, and not at some post-plan point, such as the subsequent settlement of the insurance claims or their payment, since the fire is the single irrevocable event that fixes the contractual obligation precipitating the transformation of the property, over which the corporation possesses all incidents of ownership, into a chose in action against the insurer. Pp. 417 U. S. 683-685.
(b) Section 337(a) was enacted in order to eliminate technical and formalistic determinations as to the identity of the vendor, as between the liquidating corporation and its shareholders, and, therefore, the reasons for applying § 337(a) are not present in a situation where the conversion takes place prior to the adoption of the plan when there is no question as to the identity of the owner. Pp. 417 U. S. 686-687.
481 F.2d 954, affirmed.
BLACKMUN, J., delivered the opinion of the Court, in which BURGER, C.J., and STEWART, MARSHALL, and REHNQUIST, JJ., joined. WHITE, J., filed a dissenting opinion, in which DOUGLAS, BRENNAN, and POWELL, JJ., joined, post, p. 417 U. S. 691.
MR. JUSTICE BLACKMUN delivered the opinion of the Court.
Section 337(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 337(a), [Footnote 1] provides, with stated exceptions, for the nonrecognition of gain or loss from a corporation's "sale or exchange" of property that takes place during the 12-month period following the corporation's adoption of a plan of complete liquidation that is effectuated within that period. The issue in this case is whether, when a fire destroys corporate property prior to the adoption of a plan of complete liquidation, but the fire insurance proceeds are received after the plan's adoption, the gain realized is or is not to be recognized to the corporation.
The facts are not contested. Taxpayer, Central Tablet Manufacturing Company, an Ohio corporation, for
many years prior to May 14, 1966, was engaged at Columbus, Ohio, in the manufacture and sale of writing tablets, school supplies, art materials, and related items. It filed its federal income tax returns on the accrual basis of accounting and for the fiscal year ended October 31.
On August 13, 1965, a majority of the taxpayer's production and maintenance employees went on strike. As a consequence, production was reduced to about 5% of normal volume. On September 10, during the strike, an accidental fire largely destroyed the taxpayer's plant, its manufacturing equipment and machinery, and its business offices. The damage was never repaired, the strike was never settled, and the taxpayer never again engaged in manufacturing.
At the time of the fire, the taxpayer carried fire and extended coverage insurance on its building, machinery, and inventory. It also carried business interruption insurance. Negotiations relating to the taxpayer's claim for business interruption loss began about October 8, 1965, and those on its claims for building and personal property losses began about November 1. There was dispute as to the estimated period of loss to be covered by the business interruption insurance; as to the probable duration of the strike had the fire not taken place; as to the applicability of the building policy's coinsurance clause; as to the extent of the equipment loss due to the fire, rather than to rain; as to the value of the building and equipment at the time of the fire; and as to the cost of repair of repairable machinery and equipment. The threshold liability of the insurance carriers, however, despite their not unusual rejection of the initial formal proofs of claim, was never seriously questioned.
Eight months after the fire, at a special meeting on May 14, 1966 the shareholders of Central Tablet decided to dissolve the corporation and adopted a plan of dissolution
and complete liquidation pursuant to Ohio Rev.Code Ann. § 1701.86 (1964). App. 38. About six days later, the taxpayer and the insurers settled the building claim; payment of that claim was received in mid-June. In August, the taxpayer settled its personal property claim and received payment on it in November. On May 3, 1967, all assets remaining after liquidating distributions to the shareholders were conveyed to a Columbus bank in trust for the shareholders pending the payment of taxes and the collection of remaining insurance and other claims. On the same date, the taxpayer filed a certificate of dissolution with the Ohio Secretary of State. Ohio Rev.Code Ann. §§ 1701.86(H) and (I) (1964). All this was accomplished within 12 months of the adoption of the plan on May 14, 1966.
The business interruption claim was settled in August, 1967, and payment thereof was received in September of that year.
The fire insurance proceeds exceeded the taxpayer's adjusted income tax basis in the insured property. Gain, therefore, was realized, and ordinarily would be recognized and taxed to the corporation. § 1033(a)(3) of the 1954 Code, 26 U.S.C. § 1033(a)(3); Tobias v. Commissioner, 40 T.C. 84, 95 (1963). The taxpayer, however, resorting to § 337(a), did not report this gain or any part of the business interruption insurance payment in its income tax returns for fiscal 1965 or for any other year. In January, 1968, upon audit, the Internal Revenue Service asserted a deficiency in the taxpayer's income tax for fiscal 1965. This was attributable to the Service's inclusion in gross income for that year of (a) capital gain equal to the excess of the fire insurance proceeds over adjusted basis, (b) fiscal 1965's pro rata hare of the business interruption insurance payment, and (c) an amount not at issue here. A deficiency in the taxpayer's fiscal
1963 tax was also asserted; this was attributable to a decrease in operating loss carryback from fiscal 1966 because of adjustments in the treatment of the insurance proceeds. [Footnote 2] The taxpayer paid the deficiencies, filed claims for refund, and, in due time, instituted the present action in federal court to recover the amounts so paid.
The District Court followed the decision in United States v. Morton, 387 F.2d 441 (CA8 1968), which concerned a taxpayer on the cash, rather than the accrual, basis, and held that § 337(a) was available to the taxpayer. 339 F.Supp. 1134 (SD Ohio 1972). [Footnote 3] Judgment for the taxpayer was entered. On appeal, the United States Court of Appeals for the Sixth Circuit, refusing to follow Morton, reversed and remanded. 481 F.2d 954 (1973). In view of the indicated conflict in the decisions of the Eighth and Sixth Circuits, we granted certiorari. 414 U.S. 1111 (1973).
The only issue before us is whether § 337(a) has application in a situation where, as here, the involuntary conversion occasioned by the fire preceded the adoption of the plan of complete liquidation. [Footnote 4] This depends upon whether the "sale or exchange," referred to in § 337(a),
took place when the fire occurred or only at some post-plan point, such as the subsequent settlement of the insurance claims, or their payment.
Stated simply, it is the position of the Government that the fire was a single destructive event that effected the conversion (and, therefore, the "sale or exchange") prior to the adoption of the plan of liquidation, thereby rendering § 337(a) inapplicable. It is the position of the taxpayer, on the other hand, that the fire was not such a single destructive event at all, but was only the initial incident in a series of events -- the fire; the preparation and filing of proofs of claim; their preliminary rejection; the negotiations; ultimate dollar agreement by way of settlement; the preparation and submission of final proofs of claim; their formal acceptance; and payment -- that stretched over a period of time and came to a meaningful conclusion only after the adoption of the plan, and that, consequently, § 337(a) is applicable.
In order to keep this narrow issue in perspective, it is desirable and necessary to examine the background and the history of § 337.
A corporation is a taxable entity separate and distinct from its shareholders. Ordinarily, a capital gain realized by the corporation is taxable to it. The shareholders, of course, benefit by that realization of gain and the consequent increase in their corporation's assets. The value of their shares, in theory, is thereby enhanced. This increment in value, however, is not taxed at that point to the shareholder. His taxable transaction occurs when he disposes of his shares. The capital gain realized by the corporation, and taxed to it, may be said to be subject to a "second" tax later, that is, when the shareholder disposes of his shares. There is nothing unusual about this. It is a reality of tax law, and it is due to the separateness of the corporation and the shareholder as taxable entities.
This "double tax" possibility took on technical aspects, however, when the capital gain was realized at about the time of, or in connection with, a corporation's liquidation. If liquidation was deemed to have taken place subsequent to the sale or exchange, there was a "second" tax to the shareholder in addition to the tax on the gain to the corporation. On the other hand, because a corporation itself realizes no gain for income tax purposes upon the mere liquidation and distribution of its assets to shareholders, § 311 of the 1954 Code, 26 U.S.C. § 311; see General Utilities Co. v. Helvering,296 U. S. 200 (1935), if the liquidation was deemed to have preceded the sale or exchange of the asset, there was no "first" tax to the corporation. Thus, the timing of the gain transaction, in relation to the corporation's liquidation, had important tax consequences. See generally B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders 11-53 (3d ed.1971). In short, before § 337 came into the Internal Revenue Code, the overall income tax burden for the liquidating corporate taxpayer and its shareholders was less if the corporation clearly made its distribution of assets prior to the sale or exchange of any of them at a gain.
All this seemed simple and straightforward. The application of the rule, however, as fact situations varied, engendered profound confusion which was enhanced by two decisions by this Court approximately 25 years ago. In Commissioner v. Court Holding Co.,324 U. S. 331 (1945), the Court held that a liquidating corporation could not escape taxation on the gain realized from the sale of its sole asset if the corporation itself had arranged the sale prior to liquidation and distribution of the asset to the shareholders. This was so even though the sale was consummated after the distribution. Subsequently, in United States v. Cumberland Public Service Co., 338
U.S. 451 (1950), the Court reached exactly the opposite conclusion in a case where the shareholders, rather than the corporation, had negotiated the sale of the distributed assets and, prior to the corporation's liquidation, had been in touch with the purchaser and had offered to acquire the property and sell it to the purchaser. Mr. Justice Black, who wrote for a unanimous court in both cases, recognized that
"the distinction between sales by a corporation as compared with distribution in kind followed by shareholder sales may be particularly shadowy and artificial when the corporation is closely held,"
id. at 338 U. S. 454-455, but the Court, nonetheless, determined that the distinction was mandated by the Code:
"The oddities in tax consequences that emerge from the tax provisions here controlling appear to be inherent in the present tax pattern. For a corporation is taxed if it sells all its physical properties and distributes the cash proceeds as liquidating dividends, yet is not taxed if that property is distributed in kind and is then sold by the shareholders. In both instances, the interest of the shareholders in the business has been transferred to the purchaser. . . . Congress having determined that different tax consequences shall flow from different methods by which the shareholders of a closely held corporation may dispose of corporate property, we accept its mandate."
Id. at 338 U. S. 455-456.
These two cases obviously created a situation where the tax consequences were dependent upon the resolution of often indistinct facts as to whether the negotiations leading to the sale had been conducted by the corporation or by the shareholders. Particularly in the case of a closely held corporation, where there was little, if any, significant difference between management and ownership, this analytical formalism was unsatisfactory
and, indeed, was a trap for the unwary. S.Rep. No. 1622, 83d Cong., 2d Sess., 49 (1954); H.R.Rep. No. 1337, 83d Cong., 2d Sess., A106 (1954). See Cary, The Effect of Taxation on Selling Out a Corporate Business for Cash, 45 Ill.L.Rev. 423 (1950).
It was in direct response to the Court Holding-Cumberland confusion and disparate treatment that Congress produced § 337 of the Internal Revenue Code of 1954. The report of the House Committee on Ways and Means on the bill (H.R. 8300) which became the 1954 Code explained the purpose of § 337:
"Your committee's bill eliminates questions arising as a result of the necessity of determining whether a corporation in process of liquidating made a sale of assets or whether the shareholder receiving the assets made the sale. Compare 324 U. S. Court Holding Company (324 U.S. 331), with 338 U. S. S. v. Cumberland Public Service Company (338 U.S. 451). This last decision indicates that, if the distributee actually makes the sale after receipt of the property, then there will be no tax on the sale at the corporate level. In order to eliminate questions resulting only from formalities, your committee has provided that, if a corporation in process of liquidation sells assets, there will be no tax at the corporate level, but any gain realized will be taxed to the distributee-shareholder as ordinary income or capital gain, depending on the character of the asset sold."
H.R.Rep. No. 1337, 83d Cong., 2d Sess., 38-39 (1954). See also id. at A106-A109, where it was said, at A-106: "Your committee intends in section  to provide a definitive rule which will eliminate any uncertainty." See S.Rep. No. 1622, 83d Cong., 2d Sess., 48-49, 258-260 (1954).
There is nothing in the legislative history indicating that § 337 was enacted in order to eliminate "double taxation" as such. Rather, the statute was designed to eliminate the formalistic distinctions recognized and perhaps encouraged by the decisions in Court Holding and Cumberland.See Kovey, When Will Section 337 Shield Fire Loss Proceeds? A Current Look at a Burning Issue, 39 J.Taxation 258, 259 n. 2 (1973); Note, Tax-Free Sales in Liquidation Under Section 337, 76 Harv.L.Rev. 780 (1963). See also West Street-Erie Boulevard Corp. v. United States, 411 F.2d 738, 740-741 (CA2 1969). The statute was meant to establish a strict but clear rule, with a specified time limitation, upon which planners might rely and which would serve to bring certainty and stability into the corporation liquidation area. The taxpayer here recognizes this statutory purpose. Brief for Petitioner 7; Tr. of Oral Arg. 3.
Inasmuch as § 337 was drafted to meet and deal with the Court Holding-Cumberland situation, where there had been a sale, the statute, on its face, relates only to "the sale or exchange" of property. It is not surprising, therefore, that further confusion resulted when the Internal Revenue Service found itself confronted by liquidating corporate taxpayers who sought § 337(a) treatment for casualty gains. Following the Court's decision in Helvering v. William Flaccus Oak Leather Co.,313 U. S. 247 (1941), [Footnote 5] the Internal Revenue Service at first refused to consider § 337 as applicable to a casualty situation at all. Rev.Rul. 5372, 1952 Cum.Bull. 187.
When this was rejected in the courts, [Footnote 6] the Service reversed its position and treated an involuntary conversion that occurred after adoption of a plan of complete liquidation as a "sale or exchange" with resulting nonrecognition. Rev.Rul. 64-100, 1961 Cum.Bull. (Part I) 130.
It is at this point that the issue of the instant case emerges and comes into focus. Although it is now settled that an involuntary conversion by fire is a sale or exchange under § 337(a), the question that is determinative here remains unresolved: when does the involuntary conversion by a pre-plan fire take place? Since the statute prescribes a strict 12-month post-plan period, it is crucial for the taxpayer that the conversion be deemed to have occurred after the plan of liquidation was adopted.
Predictably, the taxpayer analogizes the involuntary conversion to a true sale, and it argues that the conversion
does not occur until settlement is reached and the insurance obligations are finally determined and paid. This essentially is the reasoning employed in the Morton case.
There is nothing to indicate that Congress considered this problem when § 337(a) was adopted. The fact that attention was invariably focused on an actual sale would indicate that the casualty situation was not legislatively anticipated. Towanda Textiles, Inc. v. United States, 149 Ct.Cl. 123, 129, 180 F.Supp. 373, 376 (1960). Recourse to legislative history, therefore, is somewhat circumstantial in nature. There is, however, one guiding fact, namely, the above-mentioned clear purpose of Congress, in its enactment of § 337(a), to avoid the Court Holding-Cumberland formalities.
The taxpayer's analogy to the ordinary sale transaction has some superficial appeal. It fails, however, to give sufficient consideration to the underlying purpose of § 337(a). To be sure, under normal circumstances, a true sale is not complete until the mutual obligations (if not the precise terms) are fixed. The Internal Revenue Service has recognized this explicitly in the Regulations by making § 337(a) available where a sale is negotiated by the corporation prior to the adoption of the plan, but is not completed until after the plan is adopted. Treas.Reg. § 1.337-2(a). [Footnote 7] This merely acknowledges
that the parties are free to avoid an executory sales contract until it is made final. If the transaction is not completed until after the plan of liquidation is adopted, the corporation is rightfully entitled to § 337(a) treatment. This result is fully consistent with the aim of Congress to avoid the factual determination that led to the Court Holding-Cumberland dichotomy. The fact that the corporation and its shareholders are given this limited opportunity to plan, preliminary and prior to liquidation, for disposal of assets does not mean that the Congress intended to make this opportunity available in every conceivable fact situation.
With a fire loss, the obligation to pay arises upon the fire. ). [Footnote 8] Unlike an executory contract to sell, the casualty cannot be rescinded. Details, including even the basic question of liability, may be contested, but the fundamental contractual obligation that precipitates the transformation from tangible property into a chose in action consisting of a claim for insurance proceeds is fixed by the fire. Although the parties remain free to arrive at an acceptable settlement, the obligation itself has come into being, and it is the value of the insured property at that point that governs the claim. In other words, the terms of the obligation cannot be changed unilaterally by the insurer once the fire has occurred.
The fact that the ultimate extent of the gain may not be known or final settlement reached until some
later time does not prevent the occurrence of a "sale or exchange" even in the context of a normal commercial transaction. See, e.g., Burnet v. Logan,283 U. S. 404 (1931). The taxpayer's efforts to draw an analogy to a true sale is therefore of limited utility. See Note, Involuntary Conversions and § 337 of the Internal Revenue Code, 31 Wash. & Lee L.Rev. 417, 427-428 (1974).
When the casualty occurs during the 12-month period after the plan of liquidation is adopted, § 337(a)'s applicability follows as a matter of course. The presence of § 337(a) creates an expectation in the liquidating corporation that it will not be taxed on gains from sales or exchanges of corporate assets during the 12-month period. The taxpayer corporation then need not be concerned with the formalities of sale and disposal in order to avoid tax on capital gains. Put another way, once the plan is adopted, corporate property is colored with the reasonable expectation that, if it is sold or exchanged within 12 months, any resulting gain will not be taxed to the corporation. It follows that, if, after the plan is adopted, property is destroyed by casualty, with consequent replacement by insurance proceeds, § 337(a) treatment is available. The property colored by the expectation has been replaced by insurance proceeds.
When, however, the casualty occurs prior to the adoption of the plan and the corporation's commitment to liquidate, none of these considerations attaches. Moreover, there is nothing in the purpose of § 337 which dictates the extension of its benefits to this pre-plan situation. Before the adoption of the plan, the corporation has no expectation of avoiding tax if it disposes of property at a gain. The corporation, of course, is the beneficiary of the insurance, and, both at the time the policy is executed and at the time of the fire, the destroyed property is an asset of the corporation. Prior to the
adoption of the plan, § 337(a)'s "expectation" simply is not present. For all practical purposes, the disposal of Central Tablet's insured property occurred at the time of its fire. At that time, the taxpayer possessed all incidents of ownership. It had evidenced no intention to liquidate. The fire was irremediable. Regardless of the formalities and negotiations that prefaced the actual insurance settlements, the property was parted with at the time of its destruction. When the casualty occurs prior to the corporation's committing itself to liquidation, no Court Holding-Cumberland problem is presented.
This interpretation is fully consistent with the manner in which condemnation, the other principal form of involuntary conversion, is treated under § 337. In condemnation, the legally operative event for purposes of the statute is the passage of title under federal or state law, as the case may be, to the condemning authority. This means that, in many jurisdictions the "sale or exchange" under § 337(a) occurs prior to the determination of the amount of condemnation compensation and, indeed, possibly without advance warning to the corporation owner. Rev.Rul. 59-108, 1959-1 Cum.Bull. 72. It has been uniformly recognized that a corporate taxpayer may not avail itself of § 337(a) where its plan of liquidation is adopted after title has passed by way of condemnation even where no settlement as to condemnation price has been reached or where the corporation had no advance notice of the proposed taking. Covered Wagon, Inc. v. Commissioner, 369 F.2d 629, 633-635 (CA8 1966); Likins-Foster Honolulu Corp. v. Commissioner, 417 F.2d 285 (CA10 1969), cert. denied, 397 U.S. 987 (1970); Dwight v. United States, 328 F.2d 973 (CA2 1964); Wendell v. Commissioner, 326 F.2d 600 (CA2 1964).
The taxpayer's position here would favor the casualty taxpayer over the condemnation taxpayer.
Although perhaps not an exact parallel, the one date in the casualty loss situation analogous to the passage of title in the condemnation context is the date of the casualty. The fire is the event which fixes the legal obligation to pay the insurance proceeds. As with a nonqualifying pre-plan condemnation, the fire is the single irrevocable event of significance, and it occurs when title and control over the property are in the corporation. The chose in action against the insurer arises at that time. This is unlike the executory sales contract consummated after the adoption of a plan; there, either of the parties is free unilaterally to avoid whatever preliminary agreement had been reached at the pre-liquidation negotiations. As with condemnation, the involuntary character of the fire distinguishes it from the normal sale, and, as with condemnation, for purposes of § 337(a), it is irrelevant that the precise dollar amount of the insurer's obligation remains uncertain. In the casualty situation, the owner of the insured property is deprived of aspects of ownership when the fire occurs in much the same way as the owner of condemned property is deprived at the time title passes. In each case, the triggering event is involuntary and irrevocable. Because of the statutorily imposed chronology, the event operates to prevent the corporation's receiving the favorable treatment of § 337(a). As the Court Holding decision exemplifies, "This may appear a harsh result, but, if it is to be corrected, Congress must act; the courts have no power to do so." Dwight v. United States, 328 F.2d at 974.
Again, although not precisely parallel and certainly not controlling, concluding that the "sale or exchange" takes place at the time of the fire is consistent with the accepted
method for determining the holding period of destroyed property in the ascertainment of its long- or short-term capital gain or loss consequences. Where property is destroyed, the holding period terminates at the moment of destruction. Rose v. United States, 229 F.Supp. 298 (SD Cal.1964); Steele v. United States, 52-2 U.S. Tax Cas.