Litton Industries, Inc. v. Commissioner of Internal Revenue
89 T.C. 1086; 1987 U.S. Tax Ct. LEXIS 166; 89 T.C. No. 75 (1987)
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Rule of Law:
A pre-sale distribution from a subsidiary to its parent corporation will be treated as a dividend for tax purposes, rather than part of the sale price, if the parent corporation is definitively committed to the dividend before a binding sale agreement exists and the distribution is not part of a single, integrated transaction funded by the purchaser.
Facts:
- Litton Industries, Inc. (Litton) was the sole shareholder of Stouffer Corp. (Stouffer).
- In early 1972, Litton's management began discussing the possibility of selling Stouffer.
- On August 23, 1972, Stouffer's board of directors declared a $30 million dividend, which was paid to Litton in the form of a negotiable promissory note. At this time, Stouffer had accumulated earnings and profits exceeding $30 million.
- Two weeks later, on September 7, 1972, Litton publicly announced its intention to dispose of Stouffer.
- Over the next several months, Litton explored various options, including discussions with multiple potential buyers and preparations for a public stock offering.
- On March 1, 1973, Nestle Alimentana S.A. Corp. (Nestle) offered to buy all of Stouffer's stock.
- The sale closed on March 5, 1973, over six months after the dividend was declared, with Nestle paying Litton approximately $75 million for the stock and an additional $30 million in cash for the promissory note.
Procedural Posture:
- The Commissioner of Internal Revenue (Respondent) determined a federal corporate income tax deficiency of $11,583,054 against Litton Industries, Inc. (Petitioner) for its 1973 tax year.
- Litton Industries, Inc. filed a petition in the United States Tax Court, a court of first instance for federal tax disputes, to contest the Commissioner's deficiency determination.
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Issue:
Does a pre-sale distribution from a wholly owned subsidiary to its parent corporation, paid by a promissory note six months before a buyer is secured and a sale agreement is executed, constitute a taxable dividend or is it part of the capital gains from the subsequent sale of the subsidiary's stock?
Opinions:
Majority - Clapp, J.
Yes, the pre-sale distribution constitutes a taxable dividend. The court holds that the $30 million distribution was a dividend for tax purposes and not part of the proceeds from the sale of Stouffer's stock. The court distinguished this case from Waterman Steamship Corp. v. Commissioner, where a pre-sale dividend was recharacterized as part of the sale price. The critical distinguishing factor was the timing; here, the dividend was declared and the promissory note issued on August 23, 1972, over six months before the sale to Nestle on March 5, 1973. At the time of the dividend, there was no prearranged sale agreement or even a specific buyer. Litton committed itself to the dividend before publicly announcing the sale and accepted the consequences regardless of whether a sale was ever finalized. The court found that the dividend had independent economic substance and was not a sham transaction entered into solely for tax purposes, as Stouffer could have paid the note through other means like a public offering or borrowing.
Analysis:
This decision provides a significant clarification of the substance-over-form doctrine in the context of corporate tax planning. It establishes that the form of a transaction (a dividend followed by a sale) will be respected for tax purposes if the two steps are sufficiently separated in time and not contractually interdependent. The case creates a crucial safe harbor for taxpayers, demonstrating that a pre-sale distribution is not automatically reclassified as part of the sale price if it has independent economic significance. The ruling emphasizes timing and the absence of a pre-arranged plan as key factors, providing a roadmap for structuring dispositions to maximize after-tax proceeds while distinguishing legitimate planning from sham transactions.
