Consolidated appeal from the judgment of the United States District Court for the Western District of New York, John T. Curtin, Chief Judge, dismissing taxpayers' suits for refund of income taxes. Held, taxpayers could not utilize the installment provisions of I.R.C. § 453 to report the gain that they realized upon the disposition of their stock in a corporation in a statutory merger followed by its liquidation, because the liquidating corporation, not the acquiring corporation, was the "purchaser" of the stock within the meaning of § 453(b)(2)(A)(ii); and the Commissioner did not abuse his discretion in retroactively revoking an earlier, post-transaction ruling that shareholders could use the installment method to report gain from the disposition of their stock.
Before Lumbard, Oakes, and Van Graafeiland, Circuit Judges.
The question when income is taxable under the intricate provisions of the Internal Revenue Code is seldom a simple one. The income here consisted of gain that the taxpayers realized on the disposition of their stock in the American Steamship Company for cash and notes of an acquiring corporation. The question is whether the notes constituted "evidences of indebtedness of the purchaser," in which case taxpayers are entitled to report their gain on an installment basis under Section 453 of the Internal Revenue Code,*fn1 or instead constituted "payments" in the taxable year of sale which, when coupled with the cash that constituted 30% Of the purchase price, disentitled taxpayers from taking the benefits of Section 453 and instead made all of the gain taxable in the year of disposition. The issue, in other words, is whether the acquiring corporation was the "purchaser" of the taxpayers' stock. Resolution of that question depends on the proper characterization of the underlying corporate transaction. The taxpayers argue that because the transaction took the form of a merger under state law,*fn2 the acquiring corporation was the direct purchaser of the taxpayers' stock. But the United States District Court for the Western District of New York, John T. Curtin, Chief Judge, held that in substance the underlying transaction was a sale of American Steamship Company's assets to the acquiring corporation for its cash and notes, followed by a liquidation in which the taxpayers as stockholders of American received the cash and notes of the acquiring corporation as a liquidating distribution.*fn3 On this interpretation, American Steamship Company, not the acquiring company, was the "purchaser" of the taxpayers' stock. We agree with this interpretation and consequently affirm the judgment of the district court dismissing the taxpayers' suits for a refund of income taxes.
Two taxpayers brought suit, alleging that the Internal Revenue Service improperly disallowed their election to report the income in question on an installment basis. One, West Shore Fuel, Inc., sued for refund of taxes for a fiscal year ending July 31, 1967, and the other, Ruth A. Kolb, for the calendar year ending December 31, 1967.*fn4 As of March 1, 1967, the taxpayers owned 160 and 2 shares, respectively, of the stock of American Steamship Company (Old American), a New York corporation. On that date, pursuant to a previously executed plan, Old American was acquired by Oswego Steamship Corporation (Oswego), also a New York corporation, which as the surviving corporation in the merger changed its name to the American Steamship Company (the survivor is hereinafter sometimes referred to as New American). Under the plan, shareholders of Old American received for each share of stock a consideration of $1,950, of which 30% Or $585 was paid in cash and the balance was paid in promissory notes of New American, one in the principal amount of $1,235.96 with a maturity period of three years and the other in the amount of $129.04 with a maturity period of ten years.
The facts leading up to the transaction in question may be briefly stated as follows. Old American was engaged in the ownership and operation of ships on the Great Lakes. Oswego Shipping Corporation (Oswego Shipping) became interested in acquiring Old American to obtain a fleet of vessels capable of operating on the Great Lakes, in order to expand its business in general and to take advantage of its business contacts with ocean shippers who wanted to use Great Lakes facilities. Oswego Shipping established Oswego as a New York subsidiary. H. Lee White, chief executive officer of Oswego Shipping, approached the directors of Old American and orally offered either to purchase the assets of Old American for a price equivalent to $2,100 per share, with the stockholders to assume the burden of any and all known or contingent liabilities, or alternatively to buy all the outstanding stock of the corporation at a price of $1,900 per share. The members of the executive committee of Old American then recommended that the directors submit a counterproposal for the sale of the stock of the company at a price of $1,950 per share with any contingent liabilities to be assumed by the purchaser and without any warranties by the officers, directors, or shareholders of Old American. Mr. White responded with a proposal for a statutory merger under New York law, See note 2 Supra, with the stockholders receiving a consideration of $1,950 in cash and notes if holders of two-thirds of the stock voted in favor of the plan. Old American's directors accepted this proposal, and the plan of merger and liquidation was consummated when holders of approximately 80% Of Old American's outstanding stock voted in the plan's favor.
The final approved plan spelled out the consideration that the stockholders of Old American would receive for their stock. The plan also provided that on the effective date of the merger Old American would cease to exist and would be merged and liquidated into New American which, as the surviving corporation, would "continue the businesses of the combined constituent corporations" under Old American's corporate name. The plan further significantly provided:
Upon consummation of the merger and liquidation, all of the rights, privileges, immunities, powers and purposes, and all of the property, real and personal, causes of action and every other asset of the Company and the Buyer shall be acquired by and vest in the Surviving Corporation, and the Surviving Corporation shall assume and be liable for all the liabilities, obligations and penalties of the Company and the Buyer.
On January 10, 1968, after the merger and distribution to shareholders had been consummated and after West Shore Fuel, Inc., had filed its tax return but before Kolb had filed her return, the National Office of the Internal Revenue Service issued a so-called technical advice memorandum to the District Director of Buffalo, New York, concluding that the surrender of Old American stock for New American cash and notes constituted a sale of the stock and did not constitute a "reorganization" within the meaning of I.R.C. § 368(a)(1).*fn5 The memorandum also concluded that the "sale may be reported on the installment basis" and that the "notes will be considered to be evidences of indebtedness of the buyer." In the meantime, however, Old American had reported the transaction on its final income tax return as a sale on March 1, 1967, of the assets of Old American to Oswego, together with a liquidating distribution on that date of cash and notes to Old American stockholders. Thus Old American treated the transaction as a sale of assets and liquidation which, under I.R.C. § 337,*fn6 resulted in no recognition of any gain or loss to the corporation.*fn7 Following an audit of Old American's final return, the District Director requested the National Office to reconsider its previously issued technical advice memorandum of January 10, 1968. On March 11, 1970, the National Office retroactively revoked that ruling and determined that the overall transaction was properly to be treated as it had been in Old American's final return, viz., as a sale of assets by Old American coupled with a liquidation and distribution to Old American's stockholders of the cash and notes of New American. The National Office memorandum then concluded that the shareholders had received third party notes, not notes of the purchaser, and that the notes thus constituted "payments in the year of sale," disqualifying the transaction from installment sale treatment under the terms of I.R.C. § 453.
Taxpayers make two contentions: first, that the Government could not retroactively revoke its January 10, 1968, ruling that Old American shareholders were entitled to report the gain on the sale of their stock by the installment method; and second, that installment treatment was proper on the theory that New American, the obligor on the notes, was the "purchaser" of shares of stock sold through the medium of a statutory merger because this was the expressed intent of the parties and because as a matter of economic reality Old American shareholders sold their stock to New American and directly received cash and notes in exchange.*fn8
The first contention may be dealt with summarily. The technical advice of January 10, 1968, was not a prospective ruling on which the taxpayers relied in structuring the underlying transaction but rather was an after-the-fact ruling pertaining only to the method of accounting for a closed transaction. Thus the taxpayers were in no sense prejudiced by the retroactive revocation. Indeed, it is quite clear that the Commissioner may retroactively correct a mistake of law in his rulings even if a taxpayer Has detrimentally relied, unless the retroactive change amounts to an abuse of discretion. Dixon v. United States, 381 U.S. 68, 73-75, 85 S. Ct. 1301, 14 L. Ed. 2d 223 (1965). We find no such abuse, as well as an absence of prejudice, here. Accordingly, we pass to the merits.
Before 1926 the right of a taxpayer to report on the installment plan rested only on Treasury Regulations. When the Board of Tax Appeals held that these regulations were without statutory support, B. B. Todd, Inc., 1 B.T.A. 762 (1925), Congress in Section 212(d) of the 1926 Revenue Act permitted the taxpayer to elect to report income on an installment basis in very similar terms to the Treasury Regulations. See generally Commissioner v. South Texas Lumber Co., 333 U.S. 496, 502-03, 68 S. Ct. 695, 92 L. Ed. 831 (1948). The purpose of permitting installment treatment was to alleviate the hardship that would confront a taxpayer who sold property and received only a small percentage of the consideration in the form of cash or marketable property in the year of sale, for under ordinary accounting principles the realized gain from the entire consideration would be fully taxable in that year. See Rickey v. Commissioner, 502 F.2d 748, 753 (9th Cir. 1974).
Under the statute itself a taxpayer may report the taxable gain from the casual sale of personal property on the installment method only if in the taxable year of sale the purchaser's "payments (exclusive of evidences of indebtedness of the purchaser) do not exceed 30 percent of the selling price." I.R.C. § 453(b)(2)(A)(ii). If, however, the purchaser's year of sale payments are in the form of evidences of indebtedness of a third party, as opposed to that of the purchaser, the payments count toward the 30% Limitation. E. g., Freeman v. Commissioner, 303 F.2d 580, 584 (8th Cir. 1962); 2 J. Mertens, Law of Federal Income Taxation § 15.18, at 61 (rev. 1974). The statutory distinction, however irrational or economically arbitrary, between a purchaser's indebtedness and a third party's indebtedness was made quite knowledgeably by Congress in the 1926 Revenue Act.*fn9 The legislative history of the distinction is sparse, however, See note 9 Supra. Apparently the rationale for the distinction was that a purchaser's note might be more difficult to appraise, See S.Rep.No. 52, 69th Cong., 1st Sess. 19 (1926), Reprinted in 1939-1 C.B. 347 (Part 2), or that third party notes were more marketable.*fn10 But another possible explanation for making the distinction is that a purchaser who furnishes his own note has a continuing obligation to pay, unlike a purchaser who furnishes a third party's note and thus completes his own payment obligation once he transfers the note to the seller. ...