Granite Trust Company v. United States
238 F.2d 670, 1956 U.S. App. LEXIS 5482, 50 A.F.T.R. (P-H) 763 (1956)
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Rule of Law:
A transaction that is otherwise valid and bona fide will not be disregarded for tax purposes merely because it was entered into with the sole motive of avoiding taxes. If a taxpayer genuinely divests itself of ownership to fall outside the specific statutory requirements for non-recognition of a loss, the transaction will be given legal effect.
Facts:
- Granite Trust Company (taxpayer) created the Granite Trust Building Corporation (Building Corporation) to own its office building and owned 100% of its stock.
- Due to persistent criticism from banking authorities regarding the book value of the stock, Granite Trust planned to purchase the building from the Building Corporation and then liquidate the subsidiary.
- The planned liquidation would result in a substantial financial loss on Granite Trust's stock investment, which it wanted to recognize as a tax deduction.
- To avoid the tax code's non-recognition rule (§ 112(b)(6)) for liquidations of subsidiaries owned by 80% or more, Granite Trust sought to reduce its ownership below that threshold.
- On December 6, 1943, Granite Trust sold 20.5% of the Building Corporation's voting stock to the Howard D. Johnson Company.
- On December 10, 1943, a formal plan of liquidation was adopted for the Building Corporation.
- Following the adoption of the plan, on December 13, Granite Trust sold additional small blocks of shares and donated two shares to the Greater Boston United War Fund, further reducing its ownership.
- Shortly thereafter, the Building Corporation was liquidated, and all shareholders of record, including the recent purchasers and the charity, received a final cash distribution.
Procedural Posture:
- Granite Trust Company's claim for a tax deduction based on its liquidation loss was disallowed by the Commissioner of Internal Revenue.
- Granite Trust Company sued the United States in the U.S. District Court for the District of Massachusetts (a federal trial court) to recover the tax overpayment.
- The District Court found in favor of the defendant, the United States.
- Granite Trust Company, as appellant, appealed the judgment to the United States Court of Appeals for the First Circuit.
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Issue:
Does a parent corporation's sale and gift of a subsidiary's stock, motivated solely by the desire to avoid the non-recognition of loss provisions under § 112(b)(6) of the Internal Revenue Code, constitute a valid transaction for tax purposes?
Opinions:
Majority - Magruder, Chief Judge
Yes. A parent corporation's sale and gift of a subsidiary's stock is a valid transaction for tax purposes even if its sole motivation is to avoid a non-recognition provision of the tax code. The court reasoned that a taxpayer's motive to minimize or avoid taxation is not illicit and does not invalidate an otherwise bona fide transaction. The court distinguished this case from Gregory v. Helvering, stating that the question is whether the transaction is what it purports to be in form. Here, the sales and gift were actual, complete transfers of both legal and beneficial ownership, with no evidence that Granite Trust retained any interest. Furthermore, § 112(b)(6) is not an 'end-result' provision but one with specific, formal conditions; taxpayers are permitted to structure their affairs to deliberately fail to meet those conditions. The legislative history surrounding the subsequent reenactment of the statute also indicated Congress's understanding that taxpayers could elect to make the section applicable or inapplicable.
Analysis:
This case refines the 'substance over form' doctrine established in Gregory v. Helvering. It clarifies that a tax-avoidance motive alone is insufficient to disregard a transaction that has legal substance and is not a mere sham. The decision affirms the principle of literal compliance with the tax code, allowing taxpayers to plan their affairs to fall outside the precise statutory language of a provision they wish to avoid. It creates a significant precedent for tax planning, establishing that as long as transactions like sales or gifts are legally effective and genuinely transfer ownership, they will be respected by the courts, regardless of the underlying tax motive.
