Rev. Rul. 69-185

The Internal Revenue Service will not follow the decisions of the Court of Appeals for the Ninth Circuit in Estate of Bernard H. Stauffer v. Commissioner, 403 F. 2d 611 (1968), and Associated Machine v. Commissioner, 403 F. 2d 622 (1968), nor that portion of the decision of the Court of Appeals for the Fifth Circuit in J. E. Davant, et al. v. Commissioner, 366 F. 2d 874 (1966), certiorari denied, 386 U.S. 1022 (1967), dealing with the question whether a combination of two or more commonly owned operating corporations may qualify as a reorganization within the meaning of section 368(a)(1)(F) of the Internal Revenue Code of 1954.

Estate of Stauffer involved the consolidation under the applicable State laws of three corporations into a new corporation. Each of the transferor corporations had previously conducted an active business in a separate State. All four corporations were owned by the same sole shareholder.

The consolidation was effected on October 1, 1959. The three transferor corporations, which reported their income on a January 31 fiscal year basis, did not file final returns for the period from February 1, 1959, to September 30, 1959. Instead, the transferee corporation, which also used a January 31 fiscal year, included the pre-consolidation income of the transferor corporations in its return filed for the year ended January 31, 1960. Since the transferee corporation had incurred substantial losses during the 4-month period following its organization and the consolidation (October 1, 1959, to January 31, 1960), the effect of filing a single return covering the period from February 1, 1959, to January 31, 1960, was to offset post-consolidation losses against pre-consolidation gains without regard to the source of the gains and losses. The pre-consolidation gains were sufficient, however, to produce some taxable income for fiscal year 1960.

In addition to incurring losses during the four months of fiscal year 1960 following consolidation, the transferee corporation incurred losses during fiscal year 1961, resulting in a net operating loss for that year. Although the books of the transferee corporation indicated that the net operating loss was attributable to the operation of each of the businesses that had previously been carried on by the three transferor corporations, the transferee corporation sought to carry back the net operating loss to preconsolidation taxable years of only one of the transferor corporations.

The Tax Court of the United States, in a reviewed opinion, unanimously accepted the Service's position that the consolidation constituted a "statutory merger or consolidation" within the meaning of section 368(a)(1)(A) of the Code but did not constitute "a mere change in identity, form, or place of organization" within the meaning of section 368(a)(1)(F) of the Code. Estate of Bernard H. Stauffer v. Commissioner, 48 T.C. 277 (1967). The court held that an "F" reorganization does not extend to a multicorporate combination where each corporation has been conducting a separate business but is restricted to the reorganization of a single corporation. In reaching this conclusion the Tax Court overruled its prior decision in Pridemark, Inc., et al. v. Commissioner, 42 T.C. 510 (1964), acquiescence on another issue C.B. 1966-1, 3, reversed, 345 F. 2d 35 (4th Cir. 1965). This action by the court was consistent with the Service's position before the Tax Court in Stauffer that the decision in Pridemark regarding the application of section 368(a)(1)(F) of the Code was erroneous.

The result of the Tax Court's decision in Stauffer would have been, first, to require each of the transferor corporations to file final returns covering the period from February 1, 1959, to September 30, 1959. This requirement would have had the corollary effect of requiring the transferee corporation to file a short-period return covering the period from October 1, 1959, to January 31, 1960, the end of its first taxable year. Sections 381(b)(1) and 443 of the Code. The holding of the Tax Court that the transaction did not constitute an "F" reorganization would also have had the effect of precluding the transferee corporation from carrying back its net operating loss to prior taxable years of any of the transferor corporations. Section 381(b)(3) of the Code.

The Court of Appeals for the Ninth Circuit reversed the Tax Court's decision in Stauffer and held that under the specific facts presented consolidation of the three operating companies into a new corporation constituted an "F" reorganization. The court reached the same conclusion in a companion case, Associated Machine v. Commissioner, 403 F. 2d 622 (1968), reversing 48 T.C. 318 (1967), which involved the merger under the applicable state laws of one operating company into a second commonly owned operating company. As in Stauffer, the transferee corporation in Associated Machine sought to carry back a net operating loss incurred in a year subsequent to the merger to a prior taxable year of the transferor corporation.

Both decisions of the Court of Appeals for the Ninth Circuit rely in large part on the decision of the Court of Appeals for the Fifth Circuit in J. E. Davant, et al. v. Commissioner, 366 F. 2d 874 (1966), certiorari denied, 386 U.S. 1022 (1967). In Davant, the Court of Appeals held that the acquisition by one operating company of substantially all of the assets of a second such company, both of which were owned by the same shareholders, constituted a reorganization within the meaning of subparagraphs "D" and "F" of section 368(a)(1) of the Code. In proceedings before the Tax Court, the Service argued that the transaction was both a "D" and "F" reorganization. The Tax Court accepted the Service's argument regarding the applicability of section 368(a)(1)(D) of the Code but did not rule on the assertion that the transaction also met the definition of an "F" reorganization. South Texas Rice Warehouse Company, et al. v. Commissioner, 43 T.C. 540 (1965).

On the appeal of South Texas Rice Warehouse Company to the Court of Appeals for the Fifth Circuit, sub nom. J. E. Davant, et al. v. Commissioner, the Service abandoned the position that the transaction constituted an "F" reorganization. Instead the Service relied solely on the application of section 368(a)(1)(D) of the Code. Similarly, in opposing the taxpayer's petition for a writ of certiorari before the Supreme Court of the United States, the Service relied on the characterization of the transaction as a "D" reorganization. In proceedings before the Court of Appeals for the Ninth Circuit in Stauffer, the Service urged the court not to follow that portion of the decision of the Court of Appeals for the Fifth Circuit in Davant applying section 368(a)(1)(F) of the Code to an amalgamating reorganization.

A reorganization is defined in section 368(a)(1)(F) of the Code as "a mere change in identity, form, or place of organization, however effected".

Section 381(b) of the Code provides in part:

"(b) Operating rules.--Except in the case of an acquisition in connection with a reorganization described in subparagraph (F) of section 368(a)(1)--

"(1) The taxable year of the distributor or transferor corporation shall end on the date of distribution or transfer.

* * * * *

"(3) The corporation acquiring property in a distribution or transfer described in subsection (a) shall not be entitled to carry back a net operating loss for a taxable year ending after the date of distribution or transfer to a taxable year of the distributor or transferor corporation."

The definition of an "F" reorganization is by its terms more limited than the other reorganization definitions contained in section 368(a)(1) of the Code. It is the Service's position that the history and function of section 368(a)(1)(F) of the Code preclude its application to amalgamations of multiple operating corporations. Only by attributing this restricted scope to the definition of an "F" reorganization is it possible to give meaning to the exception in section 381(b) of the Code, with respect to the filing of final returns and the carryback of net operating losses, and to the absence of an exception for an "F" reorganization in section 381(c)(1) of the Code, which imposes restrictions on the carryover of net operating losses of a transferor corporation to taxable years of the transferee corporation in amalgamating reorganizations and certain liquidations described in section 332 of the Code.

If an "F" reorganization may encompass an amalgamation of multiple business enterprises, it is anomalous for Congress to have provided an exception in section 381(b) of the Code to the requirement of filing final returns and to have permitted the carryback of net operating losses in the case of such a reorganization without granting similar treatment of all amalgamating transactions encompassed by section 381(a) of the Code. Similarly, the absence of an exception for an "F" reorganization in section 381(c)(1) of the Code is anomalous unless Congress intended section 368(a)(1)(F) of the Code to be limited to the reorganization of a single business enterprise, in which case the transferee corporation merely continues the taxable year of the transferor corporation and takes into account the net operating loss carryovers of the transferor corporation and any losses of the transferor corporation incurred earlier in the year as if there had been no reorganization. Compare section 1.381(b)-1(a) (1) and (2) of the Income Tax Regulations with section 1.381(c)(1)-1(b), example 2, of the regulations. The dichotomy between amalgamating reorganizations and the reorganization of a single business is demonstrated in the explanation of section 381(b)(3) of the Code contained in Senate Report No. 1622, Eighty-third Congress, 2d Session, at page 276.

Accordingly, the Service will not follow as precedent in the disposition of similar cases the decisions of the Court of Appeals for the Ninth Circuit in Stauffer and Associated Machine, nor that portion of the decision of the Court of Appeals for the Fifth Circuit in Davant, holding that a transaction resulting in the combination of two or more operating corporations constitutes an "F" reorganization.

¹ Also released as Technical Information Release 1010, dated March 27, 1969.