Tsn Liquidating Corporation, Inc. v. United States
1980 U.S. App. LEXIS 14487, 624 F.2d 1328, 46 A.F.T.R.2d (RIA) 5665 (1980)
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Rule of Law:
A pre-sale distribution of assets from a subsidiary to its parent corporation is treated as a dividend for tax purposes, not as part of the consideration for the sale of the subsidiary's stock, when the buyer did not want or pay for the distributed assets and the seller genuinely retained them.
Facts:
- TSN Liquidating Corporation, Inc. ('TSN') owned over 90% of the stock of Community Life Insurance Company ('CLIC').
- CLIC's investment portfolio consisted largely of illiquid, over-the-counter securities that were considered undesirable.
- In early 1969, TSN began negotiations to sell its CLIC stock to Union Mutual Life Insurance Company ('Union Mutual').
- Union Mutual did not want to acquire CLIC's undesirable securities portfolio and structured its purchase offer to exclude the value of those assets.
- On May 5, 1969, the parties signed a Stock Purchase Agreement stipulating that certain assets would be removed from CLIC prior to closing.
- On May 14, 1969, CLIC declared a dividend in kind, distributing the unwanted securities to its shareholders, including TSN.
- On May 20, 1969, Union Mutual completed the purchase of CLIC's stock for a price that reflected the removal of the distributed assets.
- Following the acquisition, Union Mutual contributed over $1.9 million in new assets (municipal bonds and cash) to CLIC.
Procedural Posture:
- TSN reported its receipt of assets from CLIC as a dividend on its 1969 corporate income tax return.
- The Internal Revenue Service (IRS) audited TSN and recharacterized the dividend as part of the sale price, assessing additional tax.
- TSN paid the deficiency and filed an administrative claim for a refund with the IRS.
- TSN filed suit against the United States in the U.S. District Court for the Northern District of Texas to recover the tax paid.
- The district court, as the trial court, found in favor of the United States, holding that the distribution was part of the gain from the sale of the stock.
- TSN, as appellant, appealed the district court's judgment to the U.S. Court of Appeals for the Fifth Circuit.
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Issue:
For federal income tax purposes, does a pre-sale distribution of unwanted assets from a subsidiary to its parent-seller, which are retained by the parent-seller, constitute part of the consideration for the subsequent stock sale rather than a dividend?
Opinions:
Majority - Randall, Circuit Judge
No. A pre-sale distribution of assets by a subsidiary to its parent-seller is properly treated as a dividend for tax purposes, not as part of the sale consideration, when the distributed assets are unwanted by the buyer and are genuinely retained by the seller. The court distinguished this case from Waterman Steamship Corp., where a purported dividend was found to be a sham transaction because the buyer provided the funds to pay the dividend, making the subsidiary a mere conduit for the purchase price. Here, Union Mutual (the buyer) explicitly did not want the distributed assets, did not pay for them, and did not fund their distribution. TSN (the seller) retained the assets. The transaction was not a sham; the dividend had a legitimate business purpose as part of the overall sale, which was to remove assets the buyer refused to purchase. The subsequent infusion of new, different assets by Union Mutual does not transform the legitimate pre-sale dividend into part of the sale price.
Analysis:
This decision clarifies the 'substance over form' doctrine in the context of corporate acquisitions, setting a crucial precedent for distinguishing a legitimate pre-sale dividend from a disguised portion of the purchase price. The court limits the 'conduit' theory from Waterman Steamship to transactions that are shams where the buyer is the true source of the funds for the distribution. By focusing on whether the buyer wanted and paid for the distributed assets, the ruling provides a clearer framework for taxpayers to structure sales of corporate subsidiaries with unwanted assets. This holding solidifies the principle that a transaction's overall business purpose, rather than the isolated purpose of a single step, is determinative, even if a particular step results in a tax benefit.
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