American Bantam Car Co. v. Commissioner
11 T.C. 397, 1948 U.S. Tax Ct. LEXIS 81 (1948)
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Rule of Law:
For a transfer of property to a corporation to qualify as a tax-free exchange under § 112(b)(5), the transferors' 'control' is determined 'immediately after the exchange,' and a subsequent loss of control does not disqualify the exchange unless the transferors were bound by a pre-existing, unconditional, and legally binding contract to dispose of the stock at the time of the initial exchange.
Facts:
- A group of individuals known as 'the associates' (Martin Tow, E.S. Evans, and W.A. Ward, Jr.) owned business assets ('the Austin assets') subject to liabilities of $219,099.83.
- In May 1936, the associates formed a general plan to create a new corporation, the petitioner, and transfer the Austin assets to it.
- On June 3, 1936, the associates transferred the Austin assets, subject to the liabilities, and $500 in cash to the newly formed petitioner corporation.
- In exchange for the assets and cash, the petitioner issued 300,000 shares of its no-par common stock to the associates, which constituted 100% of its issued stock at that time.
- On June 8, 1936, five days after the exchange, the associates entered into a written contract with underwriters, giving the underwriters a contingent right to earn a portion of the associates' stock by selling the petitioner's preferred stock to the public.
- On August 16, 1936, the associates deposited their 300,000 shares in escrow as part of the underwriting agreement, but retained ownership.
- In October 1937, approximately 15 months after the initial exchange, one underwriter, Grant, fulfilled the conditions of the agreement and received 87,900 shares of common stock from the associates, causing their ownership to fall below the 80% control threshold.
Procedural Posture:
- The petitioner corporation calculated its depreciation deductions using a specific basis for assets acquired.
- The Commissioner of Internal Revenue determined a tax deficiency, asserting that the petitioner must use the transferors' lower, carryover basis.
- The petitioner filed a petition with the Board of Tax Appeals (the court of first instance for this type of tax dispute) to challenge the Commissioner's deficiency determination.
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Issue:
Does a transfer of assets to a corporation in exchange for all of its stock qualify as a tax-free exchange under § 112(b)(5), thereby requiring the corporation to use a carryover basis for the assets, when the transferors had a pre-existing plan to cede stock to underwriters that was not memorialized in a binding contract until after the exchange and was contingent on future events?
Opinions:
Majority - Hill, Judge
Yes, the transfer of assets qualifies as a tax-free exchange under § 112(b)(5). The court rejected the application of the step transaction doctrine, holding that the initial exchange of assets for stock was a separate and distinct transaction from the subsequent transfer of stock to the underwriter. The associates possessed 'control' immediately after the exchange because they owned 100% of the petitioner's stock, and momentary control is sufficient. The court distinguished this case from precedents where transferors were bound by a prior, unconditional written contract to dispose of the stock. Here, there was no binding contract at the time of the exchange, only an informal plan, and the subsequent contract was contingent upon the underwriters' performance. The plan to use underwriters was supplemental to the primary goal of incorporation and not a sine qua non for the initial transaction. Therefore, the exchange was tax-free, and under § 113(a)(8), the petitioner must use the transferors' carryover basis for the acquired assets.
Concurring - Leech, J.
Yes, the result is correct, but for different reasons. The various steps were integrated parts of a single plan, and the fact that the plan was not initially written is unimportant. However, the petitioner failed to establish that the corporation paid more for the assets than the transferors' original purchase price. Since the basis would be the same regardless of whether the transaction was taxable or tax-free on these facts, I concur only in the result reached by the majority.
Analysis:
This case provides a significant interpretation of the step transaction doctrine in the context of corporate formations under § 112(b)(5). It establishes that a pre-conceived plan to dispose of stock does not, by itself, break the 'control immediately after the exchange' requirement. The decision creates a more formalistic standard, requiring a legally binding and unconditional commitment to dispose of stock at the time of the exchange to integrate the steps. This precedent provides greater certainty for taxpayers structuring corporate formations, clarifying that contingent, post-exchange agreements will not necessarily defeat tax-free status, thereby narrowing the application of the more subjective 'end result' test of the step transaction doctrine.
