College of William & Mary Law School William & Mary Law School Scholarship Repository Faculty Publications Faculty and Deans 1986 Capital Gains Exception to the House's "General Utilities" Repeal: Further Indigestions from Overly Processed "Corn Products" John W. Lee William & Mary Law School, [email protected] Repository Citation Lee, John W., "Capital Gains Exception to the House's "General Utilities" Repeal: Further Indigestions from Overly Processed "Corn Products"" (1986). Faculty Publications. 1382. https://scholarship.law.wm.edu/facpubs/1382 Copyright c 1986 by the authors. This article is brought to you by the William & Mary Law School Scholarship Repository. https://scholarship.law.wm.edu/facpubs CAPITAL GAINS EXCEPTION TO THE HOUSE'S GENERAL UTILITIES REPEAL: FURTHER - INDIGESTIONS FROM OVERLY PROCESSED CORN PRODUCTS by John W. Lee I. Introduction John w.. Lee is an Associate Pr'ofessor of LEIW at · Marshall-Wythe School of Law; College of William :Urider present law a purchasingco; poration u . s~ally and Mary.. Before a,ssurriing fiis profes,sorial post, effects a cost-basis acquisition of all or a substantial part Lee practiced tax law iii Richmond, Virginia, and of another corporation's assets.either by (a) a directasset published widely on many tax subjects in scholariy . purchase from Target corporation 1* in connection with its " journals, practical guides, and learned treatises. timely liquidation (to which existing section 337 applies Mr. Lee expresses his gratitude to the American at the corporate level and section 331 at the share.holder Institute on Federal Taxation for'the opportunity to ' level), or (b) a timely purchase of "contmi" (at least 80 . present a paper and.lecture. on '7axable Corporate., . percent) of Target's stock followed b,y a timelyelediq(J,bf Acquisitions: A Transactional Analysis of Section existing section 338.. In the direct asset acquisition (l)the 338," given in Birmingham, Alabama on June 19, purchasing corporation obtains a section 1012 cost basis 1985, for which much of the basic research utilized for Target's assets2 and leilvesb,ehind Target's, ~ 'tax 1i'tt rib ~ in this article was undertaken. He also thanks Mark utes"3; (2) Targetrecognizes income iri a "buIKs'ale" of its Bader, his student, researchassfstaiit, .and friend assets orilyto the .extent of "recapture income,;' which " for his invafuable research' ror tha"t paper ' on thJ overrides the shield of existing section. 337; 4 and (3) , Corn Products doctrine and section 337. Target's shareholders recognize capital gain .on the In this article, Lee first describes the mechanics liquidating distributions by TargetS If the purchasing and ta x effects of cost basis corporate acquisitions corporation purchased the assets on credit, Target's ' and analyzes why' current tax (ules (avor 'such shareholders may reporttheir (capital) gain on the install­ acquisitions over carryover,basis acquisition (e .g., . ment method,6 thus treating principal payments on the tax-free mergers); then he describes the House's purchasing corporation's "purchaser evidences of indebt­ proposed repefll in HR 3838 of the General Utilities ' edness" distrib.uted to them in thesec~ i on 331 liquidation doctrine in current sections 336-338, focusing on of Target as payments (when received) for their Target the continued exemption for long-term cC!piJa! gains stock.7 • of a closely held active business corporation .. This Sf!ts the stage for analysis gf the Corn Products doctrine, which under ,m "integral asset" reading would deny the exemption to most appreciated operating assets, surely not the intent ,of the Commentators and experts ·, disagree as to drafters,. The article describes the conflicting iso­ whether .the cost-basis rules [aI/owed by sec­ lated sales reading, the prior case law developr:nent tions 337 and 338 of thfl Code1 mere/ylue/, or . of both readings as to depreciable operating assets (section 1231) and segtion 337, and, asks.for are the motor that drives,. the) iur.ref1t, merger",: con ~ '. ,. ~ . '.' . gressional clarification", The footnotes. explore a mania. number of policy issues, e.g., repeal of Gener.al Utilities, and additional doctrinal conflicts. Table of Contents With the Target stock acquisition route, (1) Target is treated pursuant to the purchasing corporation's electiQn ' I. Introduction ... .. 1375 of existing section 3388 as . a new corporatio'n: with a II. Proposed Limitations on General "clean slate" of tax attributes, w.hich purchased (old) Utilities , .." .. .. , ..........., . .. .. 1376 Target's assets on the day after purch'asing corporati<;>n III. Corn Products Doctrine .............. 1377 acquired such controL9 New Target corporation obtains a A. " Integral Part" Test .,.. , ............ , ..... , ,, .. .. .. ; ... 1377 cost basis in such assets equal, in uncomplicated single B. Corn Products and Section 1231 : shot 1 00 percent acquisition, to the sum Of purchasing " Integral Part" and " Isolated Trans- corporation's purchase price of such stock (including ' action" Collide .. ..... .•. ; ............. :... .. :. " ..... .. .. " " . 1378 any future p~ymerits) , and old Target's liabilities (inClud­ C . Corn Products and Existing ing the tax on old Target's recapture income);'0 (2) old Section 337 " .. .. "." .... ".... ........ ........ .. .. ... 1379 . IV. Corn Products and Proposed Sections 336-338 .. .... ....... .... .. 1380 • Footnotes begin on p. 1381 . TAX ,NOTES, Marchi 31,1986 1375 SPECIAL REPORT Target is deemed to have sold on the day purchasing nue,26 Whether acquisitions themselves would decrease corporation acquired control. all of its assets for "fair only time can tell, market value in a single transaction to which section 337 applies,"" thereby triggering ,as to old Targe~only a tax II. Proposed Limitations on General Utilities on its recapture income; and' (3) Target's shareholders The House's Tax Reform Act of 1985 (H.R 3838) recognize capital gains on the ~ale of their stock to continues ,a three decade incremental trend towards corporation,,'2lfpurchasing corporati6n'spur- ~haSing corporate level tax parity among (1) corporate distribu­ se price includes future payments, Target's share­ tions of assets to shareholders in complete liquidation holders may report their gain on the installment method. (section 336), (2) corporate (or post-distribution share­ Purchasing corporation may maintain, new Target cor­ holder) sales of Target's assets pursuant to a complete poration's existence (presumably filing con­ continued~ liquidation (section 337), and (3) shareholder sales of the solidated -i ncome tax returns)'3 or may liquidate it in a Target's ' stoc,k electively treated as a sale of Target's nonrecognition transaction receiving the assets at new assets pursuant to a pseudo-liquidation (section 338) . Target corporation's section 338(b) "cost" basis,,'4 These reforms would also partially restore corporate, In contrast under present law (1) purchasing corpora­ level parity between (a) liquidating distributions, stock tion may obtain a "carryover" basis (i..e ., old Target's sales, or asset sales on the one hand and (b) distributions basiS) in Target's assets (a) acquiring its assets or by by a continuing corporation, i.e., redemptions and divi­ stock in a " reorganization" qualifying under section 368, dends (section 311) onthe other,, 27 At the same time, H ,R. in which case (2) Target does not recognize any gain'S 3838's partial repeal of the Target level shelterin existing and purchasing corporation(or Target as an 80 percent sections 336-338 should also be viewed as but another controlled subsidiary) maintains, subject totne section " step in a 20-year trend of legislatively cutting back the 382 rules governing "carryover" of old Target'sNOLs, its scope of t,he General Utilities doctrine.28 tax attributes; ,md.(3) shareholders of old Target do not rec'ognize any gain or loss to fheextent they receive stock in purchasing corporation in the transaction and, 'of course, will have a "substituted" basis!'n such stock.'6 ' Alternatively, purchasing corporation may transactionally General Utilities commonly is said to have held elect" carryover basis by acquiring 'control of Target but that a corporation is not taxed on its non­ not electing section 338 and then maintainihg or liq'ui­ dating it, although in this event Target's shareholders will ' liquidating distributions of appreciated pro­ recognize gain ' or loss as to the consideration they perty ... receive, including any stock in purchasing corporation.'B General Utilities commonly is said to have held that a corporation is not taxed on its nonliquidating distributions H.R. 3838 continues a three decade incremental of appreciated property,29 but general usage extends the trend toward corporate level tax parity among term to present sections 336-338's shielding of a liqui­ [section 366, section 337, and section 338 dating or deemed liquidating Target from gain or loss recognition as to property it distributed in, or sold pu'r­ transactions].' suant to, a liquidation or is deemed to have sold pursuant to an elective pseudo-liquidation, except for "recapture income" in all three instances,, 3o The House proposals reverse present law: generally under revised section 336- A number of present tax law factors favor a cost-basis 338 transactions Target would be taxed as if it had sOld acquisition of Target ,or its assets over a carrYOver b,asis such property at fair market value.3' Some nonrecognition acquisition.'9 Most significant is.the