Eldon S. Chapman v. Commissioner of Internal Revenue
45 A.F.T.R.2d (RIA) 1290, 1980 U.S. App. LEXIS 19052, 618 F.2d 856 (1980)
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Rule of Law:
An acquisition of stock in a target corporation does not qualify as a tax-free Type B reorganization under § 368(a)(1)(B) if any consideration other than voting stock, such as cash, is used to acquire shares as part of a single, integrated acquisition plan, even if 80% control is acquired in a transaction solely for voting stock.
Facts:
- In October 1968, International Telephone and Telegraph Corporation (ITT) approached Hartford Fire Insurance Company (Hartford) about a potential merger, which Hartford rejected.
- Between November 1968 and January 1969, ITT purchased approximately 8% of Hartford's outstanding stock for cash from a mutual fund and on the open market.
- In April 1969, ITT and Hartford executed a provisional plan of merger, which was conditioned on shareholder and regulatory approval.
- After the merger plan was disapproved by the Connecticut Insurance Commissioner in December 1969, ITT proposed a voluntary exchange offer to Hartford's shareholders.
- In May 1970, ITT made a formal exchange offer, and more than 95% of Hartford's outstanding stock was exchanged for shares of ITT's voting stock.
Procedural Posture:
- The Internal Revenue Service (IRS) retroactively revoked a prior ruling and assessed tax deficiencies against former Hartford shareholders, including Chapman, who had participated in the stock exchange.
- Chapman and other taxpayers petitioned the U.S. Tax Court for a redetermination of the deficiencies.
- The taxpayers moved for summary judgment, conceding for the purposes of the motion that ITT's prior cash purchases were part of the 1970 exchange offer reorganization.
- The Tax Court granted summary judgment for the taxpayers, holding that the exchange qualified as a tax-free reorganization.
- The Commissioner of Internal Revenue, as appellant, appealed the Tax Court's decision to the U.S. Court of Appeals for the First Circuit.
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Issue:
Does a stock-for-stock exchange that results in over 80% control of a target corporation qualify as a tax-free Type B reorganization under § 368(a)(1)(B) if the acquiring corporation's prior cash purchases of the target's stock are considered part of the same acquisition plan?
Opinions:
Majority - Campbell, Levin H.
No. A stock acquisition fails to qualify as a tax-free Type B reorganization if non-stock consideration is used in any part of the overall acquisition plan. The court held that the statutory requirement that the acquisition be 'solely for ... voting stock' applies to the entire transaction, not just the part of the transaction that results in the acquiring corporation gaining control. The court interpreted the term 'the acquisition' to encompass all related transactions that are part of a single acquisitive plan. It reasoned that the word 'solely' leaves no leeway for other forms of consideration. This conclusion is supported by the statute's legislative history, which shows Congress explicitly permitted non-stock consideration in other types of reorganizations (like Type C) but deliberately omitted such permission for Type B reorganizations. The court also relied on longstanding precedent, most notably Helvering v. Southwest Consolidated Corp., which established the strict 'no leeway' interpretation of the 'solely' requirement.
Analysis:
This decision reaffirms the stringent and literal interpretation of the 'solely for voting stock' requirement for Type B reorganizations. By rejecting the Tax Court's more flexible approach, the court solidified the principle that any non-stock consideration in an integrated acquisition plan 'poisons' the entire transaction, preventing tax-free treatment. The case leaves open the critical factual question of how to determine when prior cash purchases are 'related' to a subsequent stock exchange, an issue it remanded for the Tax Court to decide. This ruling makes it more difficult for corporations to structure multi-step acquisitions that mix cash and stock while still achieving tax-free reorganization status for the stock portion, thus requiring careful planning to ensure transactions are sufficiently separated in time and purpose.
