In 1928, Petitioner Evelyn Gregory was owner of all of the stock of United Mortgage Corporation (UMC). UMC held, among other assets, 1,000 shares of Monitor Securities Corporation (Monitor). Ms. Gregory sought to sell the Monitor shares and limit the tax liability that would result if UMC sold the Monitor shares and subsequently transferred the amount realized from the sale to Ms. Gregory in the form of a dividend.
To accomplish this goal, Ms. Gregory attempted to utilize the Internal Revenue Code’s (IRC) reorganization provisions. On September 18, 1928, UMC formed Averill Corporation (Averill). Three days later, UMC transferred the 1,000 shares of Monitor to Averill for which all Averill shares were issued to Ms. Gregory. On September 24, 1928, Averill was dissolved and liquidated – it’s only asset, the Monitor stock, was distributed to Ms. Gregory. No other business was ever conducted, nor was any other business intended to be conducted, by Averill.
Ms. Gregory immediately sold the Monitor shares and included the resulting gain as net capital gain for the corresponding tax year. The Commissioner of Internal Revenue (Commissioner) held that Ms. Gregory was liable for a tax as though UMC paid Ms. Gregory a dividend equal to the amount realized from UMC’s sale of the Monitor shares. The Commissioner’s reasoning: The attempted reorganization by Ms. Gregory lacked substance and should thus be disregarded.
The Board of Tax Appeals (Board) rejected the Commissioner’s view and found in favor of Ms. Gregory. Upon review of the Board’s decision, the Circuit Court of Appeals sustained the Commissioner and reversed the Board, concluding that there had been no reorganization within the meaning of § 112(i)(1) of the Revenue Act of 1928. The Supreme Court granted Ms. Gregory’s writ of certiorari.
To benefit from the Revenue Act of 1928’s nonrecognition provision under which no gain is recognized on the transfer of property from one corporation to another corporation pursuant to a plan of reorganization – must a corporate reorganization conform to the technical requirements of the applicable statute AND the applicable statutory intent?
The attempted reorganization by Ms. Helvering, although in compliance with the technical requirements of the statute, was not a reorganization as the statute intended. A corporate reorganization must meet the technical requirements provided by the applicable statute and there must be a good business or corporate purpose for the reorganization. Meeting the technical requirements alone, with the sole purpose of the reorganization being the reduction of tax, does not afford the taxpayer the tax benefits of the reorganization provisions.
Key Points of Law:
- Taxpayers have an undisputed right to reduce, or altogether avoid, taxes they otherwise owe, so long as the means employed are within the law. See Superior Oil Co. v. Mississippi, 280 U.S. 390, 395-96 (1930); Jones v. Helvering, 71 F.2d 214, 217 (D.C. Cir. 1934).
- 112(i)(1)(B) of the Revenue Act of 1928 defines “reorganization” as “a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor or its stockholders or both are in control of the corporation to which the assets are transferred.”
- The discussion in § 112(i)(1)(B) of the Revenue Act of 1928 of a transfer of assets by one corporation to another is referring to a transfer made in pursuance of a plan of reorganization.
- 112(i)(1)(B) of the Revenue Act of 1928 is not discussing a transfer of assets by one corporation to another in pursuance of a plan that has no relation to the business of either entity involved, as is the case here: The reorganization was set up to disguise the true character of the situation, which was to transfer corporate shares directly to Ms. Gregory.
- The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute.
This case continues to stand for the requirement that corporate reorganizations, to be completed in a tax-free manner, must have a good business purpose. While the Court reiterated that taxpayers can, and are even expected to, arrange their affairs in a way that reduces, or allows complete avoidance of, taxes they would otherwise owe, there must be a reason beyond mere tax avoidance that justifies the business decisions being made. Where the reorganization is disregarded as lacking substance, standard taxation rules apply. Looking beyond the façade established by Ms. Gregory, what occurred was the transfer, as a dividend, of Monitor shares by UMC to Ms. Gregory.