Commissioner of Internal Revenue v. Gordon

United States Supreme Court

391 U.S. 83

Commissioner of Internal Revenue  v.  Gordon et ux.

Certiorari to the United States Court of Appeals for the Second Circuit

No. 760.  Argued: April 4, 1968 --- Decided: May 20, 1968^[1]

Pacific Telephone & Telegraph Co. (Pacific), a subsidiary of American Telephone & Telegraph Co., which owned about 90% of Pacific's stock, transferred certain of its assets to a new company, Pacific Northwest Bell Telephone Co. (Northwest), in exchange for all Northwest's common stock, and debt paper. In 1961 Pacific distributed to its shareholders rights to purchase about 57% of Northwest's common stock at $16 a share, which was below its market value. Pacific advised its stockholders that "it expected that within about three years... the Company by one or more offerings will offer for sale the balance of such stock." It also reported that the Internal Revenue Service had ruled that stockholders who sold rights distributed to them would receive taxable income in the amount of the proceeds of sale, and that stockholders who exercised rights would receive taxable income in the amount of the difference between $16 and the fair market value per share of Northwest stock obtained. In 1963 the remaining Northwest stock was similarly offered to Pacific stockholders through rights. Respondents in No. 760 were minority stockholders of Pacific who received rights pursuant to the 1961 distribution; they sold four rights and exercised the balance. Petitioners in No. 781, who also received rights in 1961, exercised them all. None of these individuals reported any income from these transactions on their tax returns and the Commissioner of Internal Revenue asserted deficiencies. The Tax Court upheld the taxpayers' contention that the 1961 spinoff distribution met the requirements of § 355 of the Internal Revenue Code of 1954, with the result that no gain should be recognized on the receipt or exercise of the rights. The Tax Court held that the sale of the four rights did result in ordinary income. No. 781 was appealed to the Court of Appeals for the Ninth Circuit, which reversed the Tax Court and held that the difference between $16 and fair market value was taxable income. No. 760 was appealed to the Second Circuit, which sustained the Tax Court on this point, but held the amount received from the sale of the rights was taxable as a capital gain rather than income.

Held:

1. When a corporation sells corporate property to stockholders or their assignees at less than its fair market value, thus diminishing the corporation's net worth, it is engaging in a "distribution of property" and such a sale results in a dividend to shareholders unless some specific exception applies. Pp. 88-91.

2. Section 355 of the Code does not provide an exception for the 1961 distribution. Pp. 91-98.

(a) The 1961 distribution did not transfer "all" the Northwest stock nor did it transfer "control" (defined in § 368 (c) as 80%), within the meaning of § 355 (a)(1)(D). Pp. 91-95.

(b) For an initial transfer or less than a controlling interest to be treated as merely the first step in the divestiture of control it must be clearly identifiable as such at the time it is made and there must be a binding commitment to take the later steps, which was not the situation here. Pp. 95-98.

(c) Since receipt and exercise of the rights produced ordinary income, receipt and sale of the rights also resulted in income taxable at ordinary rates. P. 98.

No. 760, 382 F. 2d 499, reversed; No. 781, 382 F. 2d 485, affirmed.

Solicitor General Griswold argued the cause for petitioner in No. 760 and for respondent in No. 781. With him on the briefs were Assistant Attorney General Rogovin, Harris Weinstein, Gilbert E. Andrews, and Martin T. Goldblum.

Harry R. Harrow argued the cause for respondents in No. 760 and for petitioners in No. 781. With him on the briefs were Francis N. Marshall and Stephen J. Martin.

Notes

1. Together with No. 781, Baan et ux. v. Commissioner of Internal Revenue, on certiorari to the United States Court of Appeals for the Ninth Circuit.