Aeroquip-Vickers v. CIR

• Court: Court of Appeals for the Sixth Circuit
• Decided: October 20, 2003
• Docket: 01-2741
• Status: Published

Opinion

RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Sixth Circuit Rule 206 2 Aeroquip-Vickers v. Commissioner No. 01-2741 ELECTRONIC CITATION: 2003 FED App. 0370P (6th Cir.) File Name: 03a0370p.06 _________________ COUNSEL UNITED STATES COURT OF APPEALS ARGUED: Frank P. Cihlar, UNITED STATES FOR THE SIXTH CIRCUIT DEPARTMENT OF JUSTICE, APPELLATE SECTION, _________________ TAX DIVISION, Washington, D.C., for Appellant. Thomas V.M. Linguanti, BAKER & McKENZIE, Chicago, Illinois, AEROQUIP-VICKERS, INC. AND X for Appellee. ON BRIEF: Frank P. Cihlar, Joel L. SUBSIDIARIES, f/k/a Trinova - McElvain, UNITED STATES DEPARTMENT OF - JUSTICE, APPELLATE SECTION, TAX DIVISION, Corp. and Subsidiaries, Washington, D.C., for Appellant. Thomas V.M. Linguanti, - No. 01-2741 Petitioner-Appellee, - Frederick E. Henry III, Robert S. Walton, BAKER & > McKENZIE, Chicago, Illinois, for Appellee. , v. - GIBBONS, J., delivered the opinion of the court, in which - DUGGAN, D. J., joined. CLAY, J. (pp. 19-41), delivered a COMMISSIONER OF INTERNAL - separate dissenting opinion. REVENUE, - Respondent-Appellant. - _________________ - N OPINION On Appeal from a Decision of the United States Tax Court. _________________ No. 02931-94—Mary Ann Cohen, Chief Tax Court Judge. JULIA SMITH GIBBONS, Circuit Judge. In 1986, Argued: April 30, 2003 petitioner-appellee Aeroquip-Vickers, Inc. (formerly known as Trinova Corporation, and operating as the Libbey-Owens- Decided and Filed: October 20, 2003 Ford Company (LOF) at the time), transferred all of its assets relating to a glass manufacturing business, including property Before: CLAY and GIBBONS, Circuit Judges; for which it had previously claimed investment tax credits DUGGAN, District Judge.* (ITCs) under former 26 U.S.C. § 38 (Section 38 property), into a wholly-owned subsidiary, LOF Glass, Inc. (LOF Glass). LOF then transferred LOF Glass to one of its shareholders, Pilkington Holdings, in return for Pilkington Holdings’ shares in LOF. LOF treated this transaction as a corporate reorganization under 26 U.S.C. § 368(a)(1)(D) and accordingly did not recognize any gain or loss from the exchange on the consolidated federal income tax return for * The Honorable Patrick J. Duggan, United States District Judge for 1986 that it filed together with LOF Glass. LOF also did not the Eastern District of Michigan, sitting by designation.

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report any recaptured ITCs from the transaction, as would be directors were associated with Pilkington. In late 1985, required by former 26 U.S.C. § 47(a)(1) upon the disposition Pilkington approached LOF and began negotiations of Section 38 property before the end of the property’s concerning the possibility of acquiring the glass business. estimated useful life. Earlier that year, on July 25, 1985, the board of In 1993, the Commissioner of Internal Revenue (CIR) directors of LOF approved the transfer of the glass asserted a deficiency against LOF for LOF’s failure to include business to a wholly owned subsidiary for valid business ITC recapture in income under former 26 U.S.C. § 47(a)(1) reasons. On February 19, 1986, LOF Glass, Inc. was on its 1986 consolidated tax return. Trinova petitioned the incorporated as a wholly-owned subsidiary of LOF. On United States Tax Court for a redetermination of the March 6, 1986, a “Transfer and Assumption Agreement,” deficiency. The Tax Court held that neither the transfer of the amended on April 25, 1986, transferred to LOF Glass, property from LOF to LOF Glass nor the change in ownership Inc., all assets associated with the LOF Glass Division, of LOF Glass was a disposition of Section 38 property under including inventories and receivables, effective 26 U.S.C. § 47, and that Trinova thus had no recapture retroactively to February 19, 1986. These assets also obligations. CIR appealed. For the reasons set forth below, included section 38 assets upon which LOF had we reverse the decision of the Tax Court. previously claimed ITCs. Petitioner took no formal action contemplating the liquidation of LOF Glass, Inc., I. in the event that the acquisition by Pilkington did not take place. The facts are not disputed. Pursuant to Tax Court Rule 91(a), the parties submitted a Stipulation of Facts, which the On March 7, 1986, LOF, Pilkington, and Pilkington Tax Court summarized as follows: Holdings entered into an agreement, amended on April 28, 1996, whereby LOF would transfer all of its Petitioner, an accrual basis taxpayer . . . changed its shares of LOF Glass, Inc., to Pilkington Holdings in name to Trinova from the Libbey-Owens-Ford Company exchange for all of the shares of petitioner held by (LOF) on July 31, 1986. Petitioner timely filed a Pilkington Holdings. On April 28, 1996, Pilkington consolidated Federal income tax return with certain of its Holdings exchanged 4,064,550 shares of LOF for the subsidiaries for the years at issue with the Internal shares of LOF Glass, Inc. LOF Glass, Inc., continued to Revenue Service Center, Cincinnati, Ohio, or the Internal operate the glass business as a subsidiary of Pilkington Revenue Service office in Toledo, Ohio. Petitioner was Holdings and used the section 38 assets in its trade or engaged in the fluid power and plastics businesses and business. the manufacture of glass. The glass business was referred to as “LOF Glass Division.” The parties have stipulated that petitioner recognized no gain or loss upon the transaction whereby its glass One of LOF’s largest shareholders was Pilkington business was transferred to LOF Glass, Inc., pursuant to Brothers (Pilkington), an English company, which owned the provisions of section 351 or sections 354, 355, and 29 percent of petitioner’s common stock through its 368(a)(1)(D) (except as required by such sections or wholly owned U.S. subsidiary, Pilkington Holdings, Inc. section 357(c)), and that pursuant to section 355 neither (Pilkington Holdings). Two of petitioner’s fourteen petitioner nor Pilkington Holdings recognized any gain No. 01-2741 Aeroquip-Vickers v. Commissioner 5 6 Aeroquip-Vickers v. Commissioner No. 01-2741

or loss upon the exchange of LOF Glass, Inc., shares for Under former 26 U.S.C. §§ 38 and 46, a taxpayer who the LOF shares. acquired certain machinery and equipment for use in its trade or business (Section 38 property) was allowed a credit against Before February 19, 1986, income, deductions, and its income tax liability in an amount equal to a percentage of credits with respect to the LOF Glass Division were his investment (the ITC). However, under former 26 U.S.C. included in petitioner’s return. From February 19, 1986, § 47, the ITC was limited to property that the taxpayer used through April 28, 1986, deductions and credits with in its trade or business for most of the property’s useful life. respect to LOF Glass, Inc. (the subsidiary), were If the taxpayer disposed of Section 38 property before the end included as part of petitioner’s consolidated return. After of the useful life, then the taxpayer was required to recapture April 28, 1986, LOF Glass, Inc., was no longer part of the ITC and increase its tax liability. See 26 U.S.C. petitioner, petitioner’s affiliated group, or petitioner’s § 47(a)(1). The stated purpose of this provision was “[t]o consolidated Federal income tax return. guard against a quick turnover of assets by those seeking multiple credit.” S. Rep. No. 1881, 87th Cong., 2d Sess. 11 On its 1986 consolidated return, petitioner did not (1962). include any amount of ITC recapture with respect to the LOF Glass, Inc., section 38 assets. Respondent Determining that Trinova was not liable for ITC recapture, determined that a $5,718,749 ITC recapture arose from the Tax Court emphasized that “the transactions herein took the April 1986 transaction. Petitioner does not dispute place in the consolidated return context.” Section 1.1502- the amount of the ITC recapture. . . . 3(f)(2)(i) of the Consolidated Return Regulations (CRR) states that “a transfer of section 38 property from one member On November 26, 1993, CIR issued a notice of deficiency of the group to another member of such group during a to Trinova, stating that Trinova had understated its tax consolidated return year shall not be treated as a disposition liabilities on the consolidated income tax returns that it had or cessation within the meaning of section 47(a)(1).” filed with its subsidiaries between 1985 and 1988. On Defending the Tax Court’s application of this provision to the February 18, 1994, Trinova filed a petition with the Tax Court facts in this case, Aeroquip-Vickers observes that “[a]fter contesting the deficiencies, including CIR’s recapture of ITCs [LOF] transferred the LOF Glass Division business . . . to under 26 U.S.C. § 46. On February 27, 1997, the Tax Court LOF Glass including some section 38 property, LOF Glass found in favor of Trinova on the issue of the recapture of the continued to use the section 38 property while a member of ITCs. On October 1, 2001, the Tax Court entered a decision the [LOF] affiliated group,” and thus asserts that the “transfer disposing of all claims of all parties. CIR timely filed a notice of the section 38 property to LOF Glass . . . was a non-event of appeal. under section 47; there was no ‘disposition’ of section 38 property.” In addition, Aeroquip-Vickers argues that “this II. non-event for section 37 purposes did not metamorphose into an ITC recapture event merely because LOF glass ultimately The Tax Court’s application of law to the fully stipulated left the [LOF] affiliated group” since “LOF Glass continued record is reviewed de novo. See Friedman v. Comm’r, 216 to use the section 38 property up to and following the time F.3d 537, 541 (6th Cir. 2000). that LOF Glass left the [LOF] affiliated group.” Aeroquip- Vickers thus claims that “there would be no recapture event No. 01-2741 Aeroquip-Vickers v. Commissioner 7 8 Aeroquip-Vickers v. Commissioner No. 01-2741

unless or until LOF Glass disposed of the section 38 corporation S. P and S file a consolidated federal income tax property.” (emphasis in brief). return. A and B, equal owners of P, decide to split the business into two independent corporations, one owned by A In support of its decision, the Tax Court relied upon CRR and the other owned by B. To achieve this, “P transferred all § 1.1502-3(f)(3), which provides the following examples: the assets of one of the businesses necessary to conduct the trade or business, including section 38 property, to S solely in Example (1). P, S, and T file a consolidated return for exchange for additional shares in S and immediately calender year 1967. In such year S places in service thereafter distributed all the stock of S to A. . . . A section 38 property having an estimated useful life of surrendered all its stock in P as part of the transaction.” Id. more than 8 years. In 1968, P, S, and T file a Revenue Ruling 82-20 states that: consolidated return and in such year S sells such property to T. Such sale will not cause section 47(a)(1) to apply. When there is no intention at the time of transfer to keep the property within the consolidated group, the *** transaction should be viewed as a whole and not as separate individual transactions. . . . Because the transfer Example (3). Assume the same facts as in example (1), of the section 38 property from P to S is a step in the except that P, S, and T continue to file consolidated planned transfer of the property outside the group, the returns through 1971 and in such year T disposes of the exception in section 1.1502-3(f)(2)(i) of the regulations property to individual A. Section 47(a)(1) will apply to does not apply to this transaction. Therefore, the transfer the group . . . from P to S is a disposition under section 47(a)(1) of the Code. *** Id. Example (5). Assume the same facts as in example (1), except that in 1969, P sells all the stock of T to a third Rejecting CIR’s position, the Tax Court concluded that party. Such sale will not cause section 47(a)(1) to apply. “Example 5 and not Rev. Rul. 82-20 . . . provides the key to decision herein.” Trinova Corp. v. Comm’r, 108 T.C. 68, 77 The Tax Court first noted that “the mere transfer of section 38 (1997). The Tax Court acknowledged that both the Second assets within a consolidated group does not trigger recapture” Circuit in Salomon Inc. v. United States, 976 F.2d 837 (2d and then added that Example 5 illustrated that “the transfer of Cir. 1992) and the Ninth Circuit in Walt Disney Inc. v. the stock of [LOF Glass] to Pilkington Holdings would not Comm’r, 4 F.3d 735 (9th Cir. 1993), cases involving “factual trigger the recapture of such credit.” Trinova Corp. v. situation[s] substantially similar to that involved herein,” had Commissioner, 108 T.C. 68, 73 (1997) (emphasis added). reached the opposite conclusion. However, the Tax Court CIR argues that the Tax Court erred by failing to give explained that appropriate deference to Revenue Ruling 82-20. Revenue [w]ith all due respect, we disagree with both the result rulings are official interpretations by the IRS which have been and the reasoning of the Courts of Appeals. . . . We think published in the Internal Revenue Bulletin. 26 CFR that the fact that the transfer of the assets and the transfer § 601.201(a)(6). Under the facts assumed by Revenue Ruling of the stock occurred in the same, rather than different, 82-20, parent corporation P owns 100 percent of subsidiary No. 01-2741 Aeroquip-Vickers v. Commissioner 9 10 Aeroquip-Vickers v. Commissioner No. 01-2741

taxable years does not provide a meaningful basis for In substance, if not in form, the direct and the circuitous distinguishing Rev. Rul. 82-20 . . . from Example 5 of transaction are the same. Each achieves a rapid transfer the regulations. . . . We think the Courts of Appeals for of section 38 property outside the group. To distinguish the Second and Ninth Circuits accorded the ruling undue between them would deny economic reality. Moreover, weight and that revenue rulings play a lesser role than the such a holding would allow the common parent of a language of the opinions of those Courts of Appeals consolidated group, such as EMC, to move section 38 seems to indicate. property outside the group without paying recapture taxes simply by first transferring the property to a Trinova Corp., 108 T.C. at 76-77. The Tax Court also added member subsidiary and then distributing the subsidiary’s that in this case CIR “has stipulated that there was a business stock to the third-party. Revenue Ruling 82-20’s purpose, i.e. substance, to the transfer by petitioner to [LOF requirement of recapture under these circumstances is not Glass].” Id. at 78. unreasonable. In Salomon, Engelhard Minerals and Chemicals *** Corporation (EMC) (later known as Salomon) developed a plan to separate its marketing arm and its industrial divisions The rapidity with which these components follow one into two independent companies. 976 F.2d at 838. EMC another suggest that they are, in substance, parts of one transferred the assets and liabilities of its industrial divisions overall transaction intended to dispose of the section 38 to Porocel, an existing wholly owned subsidiary (later assets outside of the consolidated group. Revenue renamed Engelhard Corporation (EC)). Id. In return, EMC Ruling 82-20 further solidifies this inference by positing received EC stock. Id. Four days later, EMC “[spun] off” EC that there is “no intention at the time of transfer to keep “by distributing all of its EC shares pro-rata to its the property within the consolidated group.” These stockholders.” Id. The IRS determined that EMC would not factual circumstances, timing and intent, differ from recognize gain as a result of the transaction. Id. at 839. those presented in CRR Example 5. They lead to the However, the IRS also noted that “[c]ertain of the machinery, conclusion that the two components are steps in a larger equipment and other assets that EMC planned to transfer to transaction which, when viewed as a whole, constitutes EC qualified as section 38 property,” and concluded that the a § 47(a)(1) “disposition.” “transfer of this property to EC followed by a spin-off to EMC shareholders [was] a ‘disposition’ which triggered Id. at 842 (citations omitted). § 47(a) recapture.” Id. at 840. Salomon brought suit to recover the recapture taxes paid. Id. The reasoning and conclusion of the Second Circuit was subsequently adopted by the Ninth Circuit in Walt Disney. In The Second Circuit concluded that Revenue Ruling 82-20 that case, Retlaw, a predecessor of Walt Disney Inc. (Disney), was not “unreasonable, nor inconsistent with prevailing law,” developed a plan to separate its “Disney assets” (including the and thus was “entitled to great deference.” Id. at 841. The commercial rights to the name “Walt Disney” and two Second Circuit explained that since a direct transfer of attractions at Disneyland) from its “non-Disney assets” (two Section 38 property was a disposition under 26 U.S.C. television stations, a cattle ranch, and several agricultural § 47(a)(1), “the more circuitous transfer by way of another properties), and then allow Walt Disney Productions consolidated group member should be as well.” Id. at 842. (Productions) to acquire Retlaw (which would only retain its No. 01-2741 Aeroquip-Vickers v. Commissioner 11 12 Aeroquip-Vickers v. Commissioner No. 01-2741

Disney assets). Walt Disney, 4 F.3d at 737. In order to transaction as a means of moving section 38 property out accomplish this, Retlaw transferred its non-Disney assets, of the group while avoiding recapture taxes”; the former which included Section 38 property, to a newly-formed, involves facts under which the transferor’s initial intent wholly owned subsidiary called Flower Street. Id. In to move section 38 property out of the consolidated exchange, Retlaw received Flower Street common stock. Id. group is undisputed. That same day, the Retlaw board of directors authorized the distribution of the Flower Street stock pro rata to the Retlaw Id. (quoting Salomon, 976 F.2d at 842) (internal citations shareholders, but specified that the distribution could only be omitted). made concurrently with the closing of Productions’ proposed acquisition of Retlaw. Id. The actual distribution occurred As the Tax Court observed, both the Second Circuit and the fifty-nine days later, immediately following the approval of Ninth Circuit afforded “great deference” to Revenue Ruling the Retlaw acquisition by Productions’ shareholders and just 82-20. This court previously has held that “[a]lthough a prior to Productions’ acquisition of the stock of Retlaw. Id. revenue ruling ‘is not entitled to the deference accorded a at 738. statute or a Treasury Regulation,’ a revenue ruling is entitled to some deference unless ‘it conflicts with the statute it Retlaw and Flower Street then filed a consolidated federal supposedly interprets or with that statute’s legislative history income tax return. Id. In the consolidated return, however, or if it is otherwise unreasonable.’” CenTra, Inc. v. United Retlaw did not recapture the ITCs it previously had taken on States, 953 F.2d 1051, 1056 (6th Cir. 1992) (quoting Section 38 property included among the non-Disney assets Threlkeld v. Comm’r, 848 F.2d 81, 84 (6th Cir. 1988)); see transferred to Flower Street. Id. As a result, the IRS assessed also Johnson City Med. Ctr. v. United States, 999 F.2d 973, a deficiency, which Disney contested. Id. Reversing the 977 (6th Cir. 1993) (“[T]his Court accords deference to decision of the Tax Court, the Ninth Circuit applied Revenue Revenue Ruling 85-74 under the standard set forth in Ruling 82-20 and determined that Disney was required to Chevron [U.S.A., Inc. v. Natural Resources Defense Council, recapture the ITC it had previously taken with respect to Inc., 467 U.S. 837, 842- 43 (1984)].”1); Wuebker v. Comm’r, Section 38 property transferred by Retlaw to Flower Street. 205 F.3d 897, 903 (6th Cir. 2000). Id. at 739. The Ninth Circuit explained that However, recent Supreme Court decisions limiting the Revenue Ruling 82-20 is not unreasonable because “[i]n Chevron doctrine have called our earlier cases into question. substance, if not in form, the direct and the circuitous In Christensen v. Harris County, 529 U.S. 576, 587 (2000), transaction are the same” and “to distinguish between the Supreme Court held that “[i]nterpretations such as those them would deny economic reality” and would allow the in opinion letters – like interpretations contained in policy common parent of a consolidated group to circumvent easily the recapture requirement. Moreover, Revenue Ruling 82-20 and Example 5 of the Consolidated Return 1 “When Congress has ‘explicitly left a gap for an agency to fill, there Regulations are not inconsistent because they address is an express delegation o f authority to the agency to elucidate a sp ecific different situations: the latter covers situations where, provision of the statute b y regulation,’ Chevron, 467 U.S. at 843-844 , and due to a “meaningful time delay” between the asset any ensuing regulation is binding in the courts unless procedurally transfer and the spin-off, there is “little reason to believe defective, arbitrary or capricious in substance, or manifestly contrary to the statute.” United States v. Mead Corp., 533 U.S. 218, 227 (2001) that the transferor corporation intends to use the (explaining the application of the Chevron test). No. 01-2741 Aeroquip-Vickers v. Commissioner 13 14 Aeroquip-Vickers v. Commissioner No. 01-2741

statements, agency manuals, and enforcement guidelines, all Reg. § 601.201(a)(6). By noting only that revenue rulings of which lack the force of law – do not warrant Chevron-style “are not entitled to the deference accorded a statute or a deference.” The Court explained that such agency Treasury Regulation,” without explicitly acknowledging that interpretations are entitled to respect, “but only to the extent some deference to revenue rulings is proper, the Tax Court that those interpretations have the ‘power to persuade.’” Id. mischaracterized the degree of deference accorded to revenue (quoting Skidmore v. Swift & Co., 323 US. 134, 140 (1944)). rulings. See, e.g., Omohundro v. United States, 300 F.3d In United States v. Mead Corp., 533 U.S. 218, 226-27 (2001), 1065, 1069 (9th Cir. 2002) (granting Skidmore deference to the Supreme Court emphasized that Chevron deference is a revenue ruling); Del Commercial Props., Inc. v. Comm’r, appropriate only “when it appears that Congress delegated 251 F.3d 210, 214 (D.C. Cir. 2001) (same); U.S. Freightways authority to the agency generally to make rules carrying the Corp. v. Comm’r, 270 F.3d 1137, 1142 (7th Cir. 2001) force of law, and that the agency interpretation claiming (same); American Express Co. v. United States, 262 F.3d deference was promulgated in the exercise of that authority” 1376, 1383 (Fed. Cir. 2001) (reasoning that “[i]n the context through “notice-and-comment rulemaking, or by some other of tax cases, the IRS’s reasonable interpretations of its own indication of a comparable congressional intent.” The Court regulations and procedures are entitled to particular added that “an agency’s interpretation may merit some deference.” (citing Cleveland Indians, 532 U.S. at 220)).2 deference whatever its form, given the ‘specialized experience Consequently, the level of deference to be accorded to and broader investigations and information’ available to the Revenue Ruling 82-20 depends upon “the thoroughness agency, and given the value of uniformity in its administrative evident in its consideration, the validity of its reasoning, its and judicial understandings of what a national law requires.” consistency with earlier and later pronouncements, and all Id. at 234 (quoting Skidmore, 323 U.S. at 139-40). In United those factors which give it power to persuade, if lacking States v. Cleveland Indians Baseball Co., 532 U.S. 200, 220 power to control.” Mead, 533 U.S. at 228 (quoting Skidmore, (2001), the Supreme Court declined to consider “whether the 323 U.S. at 140). Consideration of all of these factors leads Revenue Rulings themselves are entitled to deference.” us to conclude that some deference to Revenue Rule 82-20 is However, the Court noted that the revenue rulings at issue proper.3 “reflect the agency’s longstanding interpretation of its own regulations,” and concluded that “[b]ecause that interpretation Aeroquip-Vickers argues that “neither the ITC regime nor is reasonable, it attracts substantial judicial deference.” Id. the consolidated return regulations contain any ambiguity justifying Rev. Rul. 82-20.” Aeroquip-Vickers further When promulgating revenue rulings, the IRS does not contends that Revenue Ruling 82-20 is inconsistent with invoke its authority to make rules with the force of law. Specifically, the IRS does not claim for revenue rulings “the force and effect of Treasury Department regulations.” Rev. 2 A recent Tax Court M emorandum decision also grants a revenue Proc. 89-14, 1989-1 C.B. 814. In light of the Supreme ruling Skidmore deference. See Tedoken v. Comm ’r, 84 T.C.M. (CCH) Court’s decisions in Christensen and Mead, we conclude that 657 (20 02). Revenue Ruling 82-20 should not be accorded Chevron 3 deference. Revenue rulings do, however, constitute As Judge Swift of the Tax Court noted below in dissent, “[t]he “precedents to be used in the disposition of other cases.” Rev. weight to be given a revenue ruling is not the issue in this case. Rather, Proc. 89-14, 1989-1 C.B. 815. Revenue rulings also serve as the issue is the validity of the underlying rationale of Rev. R ul. 82-2 0.” (JA 198 .) Put differently, the amou nt of deference to be accorded to “official interpretation[s]” by the IRS of the tax laws. Treas. Revenue Ruling 82-20 ultimately turns upon the validity of its reasoning. No. 01-2741 Aeroquip-Vickers v. Commissioner 15 16 Aeroquip-Vickers v. Commissioner No. 01-2741

§ 1.1502-3(f) because the express terms of § 1.1502-3(f) do Swift of the Tax Court observed in his dissenting opinion, not explicitly refer to “intent”or “timing” requirements. As both of those decisions “rel[ied] heavily on ‘economic reality’ previously discussed, substantially similar challenges to and the ‘substance-over-form’ doctrines, which are simply Revenue Ruling 82-20 were considered and rejected by both broader labels for, and which encompass, the step transaction the Second and Ninth Circuits in Salomon and Walt Disney. doctrine.” Trinova Corp. v. Commissioner, 108 T.C. 68, 79 “Uniformity among the circuits is especially important in tax (1997) (Swift, J., dissenting). When analyzing the question cases to ensure equal and certain administration of the tax of whether the separate steps of a complex transaction should system. We would therefore hesitate to reject the view of be treated as having independent significance or as related another circuit.” Nickell v. Comm’r, 831 F.2d 1265, 1270 steps in a unified transaction, “courts have enunciated a (6th Cir. 1987). variety of doctrines, such as step transaction, business purpose, and substance over form. Although the various Moreover, the approach favored by CIR and adopted by the doctrines overlap and it is not always clear in a particular case Second and Ninth Circuits is entirely reasonable. Example 5 which one is most appropriate, their common premise is that of CRR § 1.1502-3(f) involves a situation where the asset the substantive realities of a transaction determine its tax transfer occurs in one year and the spin-off takes place in the consequences.” King Ent. Inc. v. United States 418 F.2d 511, following year, while Revenue Ruling 82-20 applies to 516 n. 6 (Ct. Cl. 1969); see also Comm’r v. Court Holding situations where (as in the instant case) the asset transfer is Co., 324 U.S. 331, 334 (1945) (“The incidence of taxation “immediately” followed by the spin-off. Whether the use of depends upon the substance of a transaction.”); Brown v. different years “merely illustrate[s] the sequence of events,” United States, 782 F.2d 559, 563 (6th Cir. 1986) (“The step as Aeroquip-Vickers argues, or rather signifies a “meaningful transaction doctrine is a judicial device expressing the time delay” between the two steps, Salomon, 976 F.2d at 842, familiar principle that in applying the income tax laws, the is an extremely close question. However, the more persuasive substance rather than the form of the transaction is interpretation is that the decision to assign different events to controlling.”) (quotation omitted). different calender years in Example 5 of CRR § 1.1502-3(f), rather than merely listing the order of events, has greater This court has applied the “end result” test in order to significance. See 2A Singer, Norman J., Sutherland Statutes determine whether the steps of a transaction should be treated and Statutory Construction, § 46.06 at 192 (2000 ed.) (“every separately or as a single unit. Brown, 782 F.2d at 563-564. word of a statute must be presumed to have been used for a “Under that test, purportedly separate transactions will be purpose”). Consequently, we conclude that the underlying amalgamated into a single transaction when it appears that rationale of Revenue Ruling 82-20 is valid, “reflect[s] the they were really component parts of a single transaction agency’s longstanding interpretation of its own regulations,” intended from the outset to be taken for the purpose of and thus deserves “substantial judicial deference.” Cleveland reaching the ultimate result.” Id. at 564 (quotations omitted) Indians Baseball Co., 532 US. at 220. (emphasis added). Aeroquip-Vickers also argues that the “step transaction A recitation of the stipulated facts supports the conclusion doctrine” is inapplicable in this case, since CIR has stipulated that LOF entered the transaction with the intent to move that valid business reasons existed for the intermediate steps Section 38 property out of the consolidated group. In late taken by LOF. The step-transaction doctrine was not directly 1985 representatives of Pilkington approached LOF addressed in either Salomon or Disney. However, as Judge concerning the possibility of acquiring its glass business. No. 01-2741 Aeroquip-Vickers v. Commissioner 17 18 Aeroquip-Vickers v. Commissioner No. 01-2741

Negotiations concerning this transaction took place between Wholesale Grocers, the Tenth Circuit held that the existence November 1985 and March 1986. LOF’s transfer of its glass of a valid business purpose does not preclude application of business and its Section 38 property to LOF Glass occurred the step transaction doctrine, explaining that “‘[a] legitimate on March 6, 1986. One day later, LOF, Pilkington, and business goal does not grant [a] taxpayer carte blanche to Pilkington Holdings entered into an agreement providing that subvert Congressionally mandated tax patterns.’” Id. at 1527 LOF would transfer all of its interest in LOF Glass to (quoting Kuper v. Comm’r, 533 F.2d 152, 158 (5th Cir. Pilkington Holdings in exchange for Pilkington Holdings’ 1976)). The substance over form inquiry thus is not as entire interest in LOF. On April 28, 1986, Pilkington narrow as Aeroquip-Vickers suggests. exchanged shares of LOF for the shares of LOF Glass. After that date, LOF Glass was no longer part of LOF’s affiliated Here, although the individual steps of the transaction had a group, nor was it part of LOF’s consolidated federal income legitimate business reason, the transaction must be treated as tax return. From the beginning, an intent on the part of LOF a single unit and judged by its end result. “To ratify a step to move Section 38 property out of the consolidated group transaction that exalts form over substance merely because without paying recapture taxes by first transferring the the taxpayer can either (1) articulate some business purpose property to LOF Glass and then distributing LOF Glass’s allegedly motivating the indirect nature of the transaction or stock to Pilkington is evident. (2) point to an economic effect resulting from the series of steps, would frequently defeat the purpose of the substance Aeroquip-Vickers argues that, unlike in Disney and over form principle.” True v. United States, 190 F.3d 1165, Salomon, in this case CIR “stipulated to the propriety not only 1177 (10th Cir. 1999). Aeroquip-Vickers has shown only the of each step but also of the entire reorganization and split- existence of a non-tax business purpose for engaging in a off.” Aeroquip-Vickers contends that since “the whole series of transactional steps “to accomplish a result [it] could transaction and each step along the way had economic have achieved by more direct means.” Id. (quoting substance,” no “tax avoidance motive” can be attributed to Associated Wholesale Grocers, 927 F.2d at 1527). LOF. Notwithstanding this business purpose, CIR correctly concluded that the intended end result of the transaction was Admittedly, this case does not involve a situation where to allow LOF to avoid liability for ITC recapture. “[t]he whole undertaking . . . was in fact an elaborate and devious form of conveyance masquerading as a corporate III. reorganization, and nothing else.” Gregory v. Helvering, 293 U.S. 465, 470 (1935) (emphasis added). Aeroquip-Vickers For the foregoing reasons, we reverse the decision of the correctly notes that CIR has stipulated that the requirements Tax Court. of 26 U.S.C. § 368(a)(1)(D) were met in this case. The individual steps of the transaction had a valid business purpose. However, “[t]he law is unclear as to the relationship between the step transaction doctrine and the business purpose requirement. Our survey of the relevant cases suggests that no firm line delineates the boundary between the two.” Associated Wholesale Grocers, Inc. v. United States, 927 F.2d 1517, 1526 (10th Cir. 1991). In Associated No. 01-2741 Aeroquip-Vickers v. Commissioner 19 20 Aeroquip-Vickers v. Commissioner No. 01-2741

______________ Commissioner. The question is whether the regulation itself or the Revenue Ruling governs the disputed transaction. DISSENT ______________ I.

CLAY, Circuit Judge, dissenting. The majority overstates In footnote three, the majority explains that “the amount of the level of deference revenue rulings receive. The Supreme deference to be accorded to Rev. Rul. 82-20 ultimately turns Court’s decision in United States v. Mead, 533 U.S. 218 upon the validity of its reasoning.” I completely agree. (2001), compels me to respectfully dissent. New circuit Mysteriously, however, the majority also states that the Tax precedents, in Omohundro v. United States, 300 F.3d 1065 Court erred “[b]y noting only that revenue rulings ‘are not (9th Cir. 2003) (per curiam), U.S. Freightways Corp. v. entitled to the deference accorded a statute or a Treasury Commissioner, 270 F.3d 1137 (7th Cir. 2001), and American regulation,’ without explicitly acknowledging that some Express Co. v. United States, 262 F.3d 1376 (Fed. Cir. 2001), deference to revenue rulings is proper.” To the extent the are cited by the majority to temper the impact of Mead. But majority implies that a revenue ruling could ever receive more as discussed below, these cases do not diminish Mead nearly deference than its persuasive value warrants, the majority is to the extent that would be necessary to reach the result incorrect. arrived at by the majority. I also wish to emphasize that assuming, arguendo, we wanted to defer to expertise, we As the majority properly notes, the Supreme Court’s would affirm the Tax Court. decision in United States v. Mead, 533 U.S. 218 (2001), restricted the scope of Chevron deference.1 Mead involved a This opinion is noteworthy because it involves a three- tariff ruling by the Customs Service that classified Mead’s judge panel of the Court of Appeals reversing (by a two-to- “day planners” as diaries for assessment purposes under the one vote) a “fully reviewed” (effectively “en banc”) eleven- Harmonized Tariff Schedule of the United States, 19 U.S.C. to-six decision by the United States Tax Court, which handles § 1202. 533 U.S. at 224. After reviewing Chevron, the Court only complex tax disputes and consists of seventeen eminent stressed that “[t]he fair measure of deference to an agency jurists who specialize exclusively in tax law. An administering its own statute has been understood to vary overwhelming majority of the Tax Court found with circumstances, and courts have looked to the degree of Commissioner’s Revenue Ruling unpersuasive, although two the agency's care, its consistency, formality, and relative of three judges of this Court find the Revenue Ruling compelling—in part because Commissioner drafted the 1 regulation. Commissioner is also a party to this dispute; in The Supreme Court foreshadowed Mea d in Christensen v. H arris fact, the IRS seeks to collect millions of dollars. The Tax County, 529 U.S. 576 (2000). Christensen declined to grant Chevron Court’s experts have no stake in the outcome. deference to an opinion letter signed by the acting administrator of the W age and Hour Division of the Department of Labor, holding that “[i]nterpretations such as those in opinion letters—like interpretations To simplify this controversy: two different kinds of tax contained in policy statements, agency manuals, and enforcement guidelines conflict. On its face, a treasury regulation, guidelines—do not warrant Chevron-style deference.” Id. at 587. § 1.1502-3(f), seems to support Taxpayer. An interpretation Christensen held that documents issued without the force of law do not of that regulation, Rev. Rul. 82-20, seems to support receive Chevron deference, see id., but the op inion p rovid ed little guidance as to when and to what types of agency statements this exception would apply. No. 01-2741 Aeroquip-Vickers v. Commissioner 21 22 Aeroquip-Vickers v. Commissioner No. 01-2741

expertness, and to the persuasiveness of the agency's The majority agrees that Chevron does not apply to revenue position.” Id. at 228 (citation omitted). Chevron applies only rulings because such rulings are issued without the force of if “Congress would expect the agency to be able to speak with law.3 See also Omohundro v. United States, 300 F.3d at the force of law when it addresses ambiguity in the statute or 1068 (“Mead involved a Customs Service tariff ruling, which fills a space in the enacted law.” Id. at 229. Furthermore, is closely akin to an IRS revenue ruling. Given that the two even if the agency has the legislative authority to act with the types of agency rulings are analogous, we are required to force of law, “the agency interpretation claiming deference apply Mead’s standard of review to an IRS revenue ruling.”); [must be] promulgated in the exercise of that authority.” Id. U.S. Freightways Corp., 270 F.3d at 1141 (declining to give at 227. The Mead Court ultimately found against the Chevron deference to IRS policy statements made without Customs Service because “the terms of the congressional notice-and-comment formalities); Am. Express Co. v. United delegation give no indication that Congress meant to delegate States, 262 F.3d at 1382-83 (stating that IRS decisions not authority to Customs to issue classification rulings with the force of law.” Id. at 232-33. Mead explained that “a very good indicator of delegation that have the legal force, C ongress clearly so indicates. See, e.g., I.R.C. § 40(f)(3) (authorizing the Secretary to prescribe by regulation the manner meriting Chevron treatment is express congressional in which taxpayers ma y elect no t to have alcohol fuel credits ap ply); id. authorizations to engage in the process of rulemaking or at § 414(o) (authorizing the Secretary to prescribe regulations necessary adjudication that produces regulations or rulings for which to achieve the purposes of the low income housing credit); id. at § 42(o) deference is claimed.” 533 U.S. at 229. According to Mead, (authorizing the Secretary to prescribe regulations to preven t avoidance when Congress wants an agency to act with legal force, it of emp loyee b enefit provisions). A Treasury Regulation expressly states wants the agency to guarantee “fairness and deliberation,” that revenue rulings “do n ot have the force and effect of Treasury Department regulations” (which do have legal force). Rev. Proc. 89-14, which the use of a “relatively formal administrative procedure 1989-1 C.B. 814. tends to foster.” Id. at 230. Mead also states that notice-and- comment procedures are not the only indicator that Congress 3 However, the majority tries to minimize this. After writing that, intended an agency to act with the force of law, because “[i]n light of the Supreme Court’s decisions in Christensen and Mead, we “other statutory circumstances” may sometimes signal the conclude that Revenue Ruling 82-20 should not be accorded Chevron same legislative objective. Id. 229. The Court, however, deference,” the majority notes that “revenue rulings do, however, cited only one case, NationsBank v. Variable Annuity Life constitute ‘precedent[s] [to b e used ] in the disposition of o ther cases.’ Rev. Proc. 89-14, 1989-1 C.B. 815. Revenue rulings also serve as Insurance Co., 513 U.S. 251 (1995), in which an agency ‘official interpretation[s]’ by the IRS of the tax laws. Treas. Reg. ruling received Chevron deference without notice-and- § 601.201(a)(6).” (alterations in majority op.). Yet neither the fact that comment procedures.2 revenue rulings are “official” or serve as precedent for the IRS to use in other cases gives revenue rulings lega l force. See Rev. Proc. 89-14, 198 9-1 C.B. 814. U nder Mead, the absence of legal force is the primary 2 indicia of a regulation w arranting only Skidm ore deference, see Mead, It is hard to understate Mead’s importance. Justice Scalia described 533 U.S. at 232-33, and neither the “officiality” of revenue rulings nor the the decision as “one of the most significant opinions ever rendered by the Treasury Department’s intent that the IRS use revenue rulings to guide Court dealing with the judicial review of administrative action.” 533 U.S. subsequent decisions makes the revenue ruling itself likely to better at 261 (Scalia, J., dissen ting). Mead effectively limits Chevron to withstand Skidm ore scrutiny because neither factor makes the revenue situations in which the agency can show “affirmative legislative intent” ruling necessarily more thoroughly considered, consistent, valid, or that it has lawmaking power. Id. at 239 (Scalia, J., dissenting). When otherwise persuasively reasoned. See Skidmore v. Swift & Co., 323 U.S. Congress intends for the Treasury Departm ent to issue policy statements 134, 140 (1940). No. 01-2741 Aeroquip-Vickers v. Commissioner 23 24 Aeroquip-Vickers v. Commissioner No. 01-2741

adopted in regulations after notice and comment are probably 1065, grants Skidmore “deference.” But as explained, not entitled to Chevron deference). The Mead Court noted Skidmore “deference” relies on the “power to persuade.” that agency statements ineligible for Chevron deference may Omohundro granted “deference” only after ruling, “First, the still receive Skidmore deference. Mead, 533 U.S. at 234-35 IRS's reasoning is valid.” Id. at 1068. The “deference” (“Chevron left Skidmore intact and applicable where statutory accorded was to persuasive reasoning, not merely to IRS circumstances indicate no intent to delegate general authority interpretive authority. The majority in the present dispute to make rules with force of law, or where such authority was accords deference based upon the Revenue Ruling itself, apart not invoked.”) from its persuasive power. In Skidmore v. Swift & Co., 323 U.S. 134 (1944), the Court The second case cited, Del Commercial Props., Inc. v. gave an agency pronouncement only the weight it deserved in Comm’r, 251 F.3d 210, 214 (D.C. Cir. 2001), was released light of “the thoroughness evident in its consideration, the ten days before Mead. Given that the majority acknowledges validity of its reasoning, its consistency with earlier and later the relevance of Mead, it is not clear why this case is cited. pronouncements, and all those factors which give it power to persuade.” Id. at 140. The third case cited by the majority, U.S. Freightways Corp. v. Comm’r, 270 F.3d at 1139, states: When the majority claims the Tax Court erred by failing to acknowledge that “some deference to revenue rulings is Although we acknowledge that even after United States proper” (emphasis added), the majority overstates Skidmore v. Mead Corp., 533 U.S. 218, 150 L. Ed. 2d 292, 121 S. “deference.” Skidmore “deference” does not always involve Ct. 2164 (2001), we owe some deference to the “deferring” because the level of respect afforded the agency Commissioner's interpretation of his own regulations, we pronouncement depends on its “power to persuade.” conclude here that the lack of any sound basis behind the Skidmore, 323 U.S. at 140. An agency pronouncement with Commissioner's interpretation, coupled with a lack of no persuasive power receives no deference. Therefore, consistency on the Commissioner's own part, compels us because the Tax Court majority found the Treasury to rule in favor of Freightways. Department’s justification for its revenue ruling unpersuasive, the Tax Court did not err by failing to acknowledge that This statement highlights again the importance of Mead. “some deference to revenue rulings is proper.” Likewise, to While U.S. Freightways professes to accord some the extent this Court finds the Treasury Department’s “deference,” it is not at all clear that the term is being used to rationale unpersuasive, we have no obligation to defer. signify anything substantially beyond than the “power to Exactly as the majority explains, “the amount of deference to persuade,” under Skidmore. After all, as stated in the quoted be accorded to Revenue Ruling 82-20 ultimately turns upon passage above, U.S. Freightways rejected the Commissioner’s the validity of its reasoning.” ruling, which severely calls into question the amount of true deference that was actually given by the Seventh Circuit. The majority cites a string of four cases in support of its statement that even after Mead “some deference to revenue The last case cited by the majority is Am. Express Co., 262 rulings is proper.” Yet none of these cases push Skidmore F.3d 1376. This case, unlike U.S. Freightways, held in favor “deference” to the level that the majority would have in the of the Commissioner. However, American Express is readily present case. The first case cited, Omohundro, 300 F.3d distinguishable from the present case. In American Express, No. 01-2741 Aeroquip-Vickers v. Commissioner 25 26 Aeroquip-Vickers v. Commissioner No. 01-2741

the court ruled that the interpretation was not at all in conflict interpretation in Rev. Rul. 82-20. These cases are with the applicable regulation, since on its face the regulation distinguishable and outdated. simply did not address the issue at hand. Id. at 1381 (“There is nothing on the face of IRS Rev. Proc. 71-21 that defines the In both Disney and Salmon, the taxpayers sought rulings term ‘services,’ . . . .”). By contrast, in the present case, the from the IRS as to whether they would qualify for tax-free regulation on its face addressed the issue with sufficient “D” reorganizations. Disney, 4 F.3d at 737; Salomon, 976 clarity to warrant a ruling from the Tax Court, in favor of F.2d at 839. Also in both cases, the taxpayers represented to Taxpayer. Thus, even though American Express professed to the IRS that they would recapture ITCs associated with accord “deference” to the IRS interpretation, the context in property transferred to newly formed subsidiaries. The IRS that case was such that the amount of actual deference then issued private letter rulings stating that the transactions accorded was not nearly as great as that accorded by the would qualify as tax-free “D” reorganizations. See Priv. Ltr. majority in the present case. Rul. 8215003 (Oct. 22, 1981) (Disney ruling); Priv. Ltr. Rul. 8132115 (May 18, 1981) (Salomon ruling). Each taxpayer While the language contained in Omohundro, U.S. then reorganized its business, but did not recapture the ITCs. Freightways, and American Express does indicate that even Disney, 4 F.3d at 736; Salomon, 976 F.2d at 838. In the after Mead some “deference” is due to revenue rulings, it is ensuing litigation, Commissioner did not challenge the not at all clear that this deference is anything more than effectiveness of the reorganizations, see Disney, 4 F.3d at Skidmore “deference,” which simply mandates that the 738; Salomon, 976 F.2d at 839, but Commissioner never reviewing court must consider agency interpretations, expressly stipulated that the transactions met the requirements examining them for their “power to persuade.” of §§ 355 and 368(a)(1)(D). In contrast, Commissioner made that stipulation in this case, which means Commissioner The following sections explain why the government’s concedes that the split-off was “not used principally as a reasoning is invalid. device for the distribution of the earnings and profits” of LOF or LOF Glass. See I.R.C. § 355(a)(1)(B).5 II. Unlike the majority, I see no reason to rely on two equally 5 antiquated decisions from other circuits that deal with As the majority notes, the Salomon court depended heavily on its ostensibly similar tax controversies.4 Both Walt Disney, Inc. conclusion that v. Comm’r, 4 F.3d 735 (9th Cir. 1993), and Salomon, Inc. v. [i]n substance, if not in form, the direct and the circuitous Comm’r, 976 F.2d 837 (2d Cir. 1992), accepted Petititoner’s transaction are the same. Each achieves a rapid transfer of section 38 p roperty outside the group. To distinguish between them would deny economic reality. Mo reover, such a holding 4 would allow the com mon parent of a co nsolidated group . . . to The majority properly emphasizes that “‘[u]niformity among the move section 38 property outside the group without paying circuits is especially important in tax cases to ensure equal and certain recapture taxes simply by first transferring the property to a administration of the tax system.’” (quoting Nickell v. Comm’r, 831 F.2d member subsidiary and then distributing the subsidiary’s stock 1265, 127 0 (6th Cir. 1987)). This principle does not limit our obligation to the third -party. to react to new Suprem e Court decisions. As discussed further below, the majo rity wrongly relies on Chevron-era tax precedents. We canno t ignore 976 F.2d at 842. Disney then quotes this text. See 4 F.3d at 73 9. W e Mead in the nam e of co nsistency. cannot conclude that Respondent intended “to mo ve section 38 property No. 01-2741 Aeroquip-Vickers v. Commissioner 27 28 Aeroquip-Vickers v. Commissioner No. 01-2741

Even without this distinction, neither Disney nor Salomon Secretary consents to deconsolidation. I.R.C. §§ 1501, 1504; should influence this Court. Both Disney and Salomon Treas. Reg. 1.1502-75. Congress and the Treasury explicitly stated that IRS revenue rulings deserve “great Department realized that “[i]n substance, there was little deference.” Disney, 4 F.3d at 740-41; Salomon, 976 F.2d at distinction between a corporation that chose to conduct its 841. We cannot know what conclusion the Salomon or business by means of divisions and another corporation that Disney courts would have reached had they not afforded the preferred to operate its various businesses through Commissioner “great deference” revenue rulings subsidiaries.” CRESTOL, ET AL., THE CONSOLIDATED TAX unquestionably no longer receive. See Omohundro v. United RETURN ¶ 1.01 at 1-2 (5th ed. 2000). Therefore, consolidated States, 300 F.3d at 1068; U.S. Freightways Corp., 270 F.3d returns allow parents and subsidiaries to be treated as though at 1141; Am. Express Co., 262 F.3d at 1382-83. This they were a “single taxpayer.” Commissioner concedes that tremendous difference makes Disney and Salomon the economic approach underlying the consolidated return inapplicable in contemporary tax litigation. regime is the “single taxpayer theory.” (Comm’r Br. at 14- 16.) As noted, the majority offers no response to this III. argument. The next step is to consider whether the Commissioner has B. offered a persuasive position. Congress delegated authority to the Treasury Department A. to promulgate regulations governing the distribution of tax credits among the members of a consolidated group. The consolidated return provisions in the tax code allow Accordingly, the Secretary of the Treasury instituted multiple corporations (including a parent and subsidiaries) to § 1.1502-3, which covers the handling of “consolidated tax file a single consolidated tax return. I.R.C. §§ 1501, credits,” including the disposition of Section 38 property. See 1504(a)(1). The majority notes this, but fails to recognize Treas. Reg. § 1.1502-3(f). Under section 1.1502-3(f)(2)(i): how the single taxpayer theory implicates the present controversy. a transfer of Section 38 property from one member of the group to another member of such group during a To file a consolidated return, each subsidiary must be consolidated return year shall not be treated as a linked, directly or indirectly, to the common parent by an disposition or cessation within the meaning of section ownership chain of both 80% of the voting power of the 47(a)(1). If such Section 38 property is disposed of, or subsidiary and 80% of the value of the subsidiary’s stock. otherwise ceases to be Section 38 property or becomes I.R.C. § 1504(a)(2). Once a group of corporations elects to public utility property with respect to the transferee, file a consolidated return, the corporations must remain in the before the close of the estimated useful life which was group unless they cease to qualify as group members or the taken into account in computing qualified investment, then section 47(a)(1) or (2) shall apply to the transferee with respect to such property (determined by taking into outside the group witho ut paying recapture taxes,” see Salomon, 976 F.2d account the period of use, qualified investment, other at 842, when Co mmissioner concedes that the split-off was “not used dispositions, etc., of the transferor). Any increase in tax principally as a de vice for the distribution of the earnings and profits.” due to the application of section 47(a)(1) or (2) shall be See I.R.C. § 355(a)(1)(B). No. 01-2741 Aeroquip-Vickers v. Commissioner 29 30 Aeroquip-Vickers v. Commissioner No. 01-2741

added to the tax liability of such transferee (or the tax The sale from S to T will not cause section 47(a)(1) to liability of a group, if the transferee joins in the filing of apply. a consolidated return). Example (3). Assume the same facts as in example (1), (emphasis added). Thus, the regulation tests the transferee to except that P, S, and T continue to file consolidated determine whether it must recapture ITCs and whether the returns through 1971 and in such year T disposes of the transferee may report the recapture on its separate return (if it property to individual A. Section 47(a)(1) will apply to has left the consolidated group) or the consolidated group the group and any increase in tax shall be added to the return (if the transferee remains a member of the group).6 No tax liability of the group. For the purposes of other consolidated return regulation addresses ITC recapture determining the actual period of use by T, such period and no other regulation explicitly requires ITC recapture shall include S's period of use. when a transferee of Section 38 property is split-off from the affiliated group in a valid “D” reorganization. The majority Example (4). Assume the same facts as in example (3), offers no response to this argument. except that T files a separate return in 1971. Again, the actual periods of use by S and T will be combined in C. applying section 47. If the disposition results in an increase in tax under section 47(a)(1), such additional tax Once § 1.1502-3(f)(2)(i) imposes transferee liability for shall be added to the separate tax liability of T. ITC recapture on consolidated group members, § 1.1502- 3(f)(3) provides five illustrations of how § 1.1502-3(f)(2)(i) Example (5). Assume the same facts as in example (1), will apply: except that in 1969, P sells all the stock of T to a third party. Such sale will not cause section 47(a)(1) to apply. Example (1). P, S, and T file a consolidated return for calendar year 1967. In such year S places in service When closely scrutinized, these examples vindicate Section 38 property having an estimated useful life of Taxpayer’s position. more than 8 years. In 1968, P, S, and T file a consolidated return and in such year S sells such property In example one, P, S, and T are members of a consolidated to T. Such sale will not cause section 47(a)(1) to apply. group at all times. There is no § 47 disposition of the Section 38 property when S obtains it and sells it to T, because T has Example (2). Assume the same facts as in example (1), simply assumed S’s role. except that P, S, and T filed separate returns for 1967. In example two, S acquires the property from P before the corporations become members of a consolidated group. S then transfers the property to T after the corporations form 6 a consolidated group. P still did not engage in a § 47 transfer This is different from the ITC provisions in the I.R.C. § 47(a)(1) and because the entire transaction occurred within a consolidated (2). In § 47, while a transfer betwe en non-consolidated group members may constitute a “mere change in form that does not trigger recapture,” group. it is the transferor that the IRS holds liable for the recapture if the transferee disposes of the property or the transferor dispo ses of its interest in the transferee. T he transferee has no liability at all. I.R.C . § 47 (b). No. 01-2741 Aeroquip-Vickers v. Commissioner 31 32 Aeroquip-Vickers v. Commissioner No. 01-2741

In example three, the corporations acquire and transfer the group, T will be liable.8 The original transferor has no post- Section 38 property while belonging to a consolidated group, transfer recapture liability. but T then transfers the Section 38 property to some unrelated party. This triggers a § 47 ITC recapture for which the Example five reflects precisely what happened in this case. consolidated group is responsible.7 A parent (LOF) transferred Section 38 assets to a subsidiary (LOF Glass) that was a member of the parent’s consolidated In example four, when T transfers the Section 38 property group. The parent then transferred its stock in the subsidiary to an unrelated third party, P, S, and T are no longer members to a third party outside the consolidated group (Pilkington).9 of a consolidated group. Thus, T files a separate return. T’s According to example five, any liability for recapture lies transfer outside the group triggers the ITC recapture and that with the transferee, not with the original parent/transferor. “additional tax shall be added to the separate tax liability of T.” Treas. Reg. § 1.15.02-3(Ex. 4). The liability is not D. imposed on S, the transferor of the Section 38 property, or P, the other group member. Transferee liability is imposed on In Rev. Rul. 82-20, 1982-1 C.B. 6, the IRS considered the T. This reflects the policy embedded in § 47 and the ITC application of the ITC recapture provisions of the IRC and the provisions that the responsible entity (now T) must continue consolidated return regulations. Specifically, the IRS applied to use Section 38 property its trade or business for the § 1.1502-3(f) to a corporate reorganization which, as in this appropriate period. case, qualified under §§ 355(a)(1) and 368(a)(1)(D) for nonrecognition treatment. The ruling involved a transfer of In example five (like example one), the Section 38 property assets, including Section 38 property, by a parent corporation was acquired by S and transferred to T while all parties to its wholly-owned subsidiary, followed by a distribution of remained members of a consolidated group. When P sells T’s the subsidiary’s stock to one of the parent corporation’s stock to a third party, no recapture occurs. The rule of shareholders. Since the parent and the subsidiary filed a transferee liability dictates that there is no ITC recapture consolidated tax return, the situation addressed in the because T remains liable for ITC obligations as the transferree Revenue Ruling is very similar to that presently before this of Section 38 property. If T disposes of the property, ceases Court. using it in its trade or business, or joins a new consolidated The ruling initially noted that under Treas. Reg. § 1.47- 3(f)(5)(ii) a recapture determination is required when the transferor of the Section 38 property does not retain a substantial interest in the subsidiary. This is in tension with 7 § 1.1502-3(f)(2)(i), which does not treat the transfer from one Commissioner argues that this result occurs because the regulations (and exam ples) assume that the co nsolidated group mem bers initially intended for the property to remain within the group. This speculation 8 ignores § 1.1502-3(f)(2), which imposes liability based on whether or not If T joins a new consolidated group, then T and the other members an intra-group transfer took place, not whether or not the parties intended of the new consolidated gro up wo uld then be liable. See Tre as. Reg. the Section 38 assets to rem ain in the group after the transfer. N otably, § 1.1502 -3(f)(2). the regulations contemplate that T may leave the group and file its own 9 return or a return with a new consolidated group . See Treas. Reg. As described above, this transfer occurred in exchange for the third § 1.1 502 -3(f)(2)(i). party’s (Pilkington’s) stock in the parent (LOF). No. 01-2741 Aeroquip-Vickers v. Commissioner 33 34 Aeroquip-Vickers v. Commissioner No. 01-2741

member of a consolidated group to another as a § 47 not sell the transferee’s stock until 1969. § 1.1502-3(f)(3) disposition. To reconcile these provisions, the Commissioner (Ex. 5). Commissioner concludes that the parent does not assumed that the consolidated return regulation, § 1.1502- recapture the ITCs in this example only because the parent 3(f)(2)(i), was “premised on the assumption that the property waited a year before selling the transferee’s stock.10 Since [would] remain[] within the consolidated group. When there the hypothetical parent waited a year, the consolidated group is no intention at the time of the transfer to keep the property must not have “intended” to move the assets outside of the within the consolidated group, the transaction should be group when it transferred them within-group to its subsidiary. viewed as whole and not as separate transactions.” Rev. Rul. 82-20. This extraordinarily strained hypothesis is hard to accept primarily because the relevant regulations never mention The rationale, according to the Commissioner, is that a intent. One cannot reasonably believe that the Treasury parent corporation’s transfer of Section 38 property to its Department meant an intent test but, rather than saying so wholly-owned subsidiary is not treated as a disposition so expressly, it said so through the circuitous route long as the parent corporation substantially owns the Commissioner defends. A parent company could certainly subsidiary. I.R.C. § 47(b). When such a transfer is followed wait a year before transferring assets outside the consolidated by a split-off of the subsidiary’s stock, however, recapture is group, yet have intended to make the transfer from the outset. imposed immediately because the transferor no longer retains Most likely, example five has the relevant events occurring in a “substantial interest” in the transferee. If the government different years simply to make the hypothetical as simple and has correctly interpreted § 1.1502(f)(2)(i), then Taxpayer clear as possible with respect to the order in which the must recapture the ITCs. The majority offers no response to transactions take place. That certainly seems a more plausible this argument. explanation than to assume the reference to a different year somehow implies an intent standard. It also seems reasonable E. that the Treasury Department merely wanted example five to illustrate the clear language in § 1.1502-3(f)(2), which places Rev. Rul. 82-20 is inconsistent with § 1.1502(f)(2)(i) obligations on the transferee without discussing the because the treasury regulation focuses on making the transferor’s intent.11 transferee responsible for the Section 38 property, whereas the Revenue Ruling looks to the “intent” of the parties in the consolidated group. Depending on whether the parties in the 10 consolidated group intended to transfer the Section 38 This example stand in contrast to this case, in which the parent property to a third party ultimately, either the transferor or the waited only a weekend to make the transfer. transferee may have to recapture the ITCs. 11 Trea s. Reg. § 1.1502-3(f)(2)(i) states: First, if intent were the decisive factor under the regulation, the regulation would make that clear. Commissioner argues a transfer o f Section 38 property from one member of the group to another member of such group during a consolidated return that the regulation does make that clear, because in crucial year shall not be treated as a disposition or cessation within the example five, the parent, subsidiary, and transferee file meaning of section 47(a)(1). If such Section 38 property is consolidated returns in 1967 and 1968, and the subsidiary disposed of, or otherwise ceases to be Section 38 property or transfers its Section 38 property in 1968, but the parent does becomes public utility property with respect to the transferee, before the close of the estimated useful life which was taken into No. 01-2741 Aeroquip-Vickers v. Commissioner 35 36 Aeroquip-Vickers v. Commissioner No. 01-2741

Second, the interpretation in Rev. Rul. 82-20 fails to respect return regulations. As already noted, according to I.R.C. the single-taxpayer theory that underlies the consolidated § 47(a) (1) and (2), if a transfer between non-consolidated group members triggers recapture, the transferor is liable for the recapture while the transferee has no liability. I.R.C. § 47(b); Treas. Reg. § 1.47-3(f)(5). The single taxpayer account in computing qualified investment, then section 47(a)(1) theory, however, involves ignoring transactions between or (2) shall apply to the transferee with respect to such p roperty (determined by taking into account the period of use, qualified members of a consolidated group. By attempting to impose investment, other dispositions, etc., of the transferor). Any recapture liability on the transferor, Commissioner would increase in tax due to the application o f section 47(a)(1) or (2) create situations—like this one—where liability would remain shall be ad ded to the tax liability of such transferee (or the tax with the group even after the subsidiary holding the assets has liability of a group, if the transferee joins in the filing of a left. This conflicts with the single-entity approach by treating consolidated return). a now-separate corporation as though it still belonged to the (emp hasis added ). consolidated group.12 It is significant, therefore, that the Supreme Court attempts to interpret the consolidated return The majority claims that: regulations in a manner consistent with the single-entity theory. See United Dominion Industrs. v. United States, 532 the more persuasive interpretation is that the decision to assign U.S. 822 (2001) (holding that the single-entity approach is the different events to different calendar years in Example 5 of CRR § 1.1502-3(f), rather than merely listing the order of events, has proper method for calculating product liability losses among greater significance. See 2A S inger, N orman J., Sutherland a consolidated group). Statutes and Statutory Construction, § 46 .06 at 192 (2000 ed.) (“every word of a statute must be presumed to have been used Due to the single-taxpayer theory embodied in the for a purpo se”). consolidated return regulations and the resulting transferee The majo rity wants to infer an intent test because example five lists liability imposed on LOF Glass for the ITC recapture, LOF’s separate calend er years, instead of simp ly the ord er of events. T his transfer of the Section 38 property to LOF Glass did not argument is silly. Had the Commissioner listed the order of events, rather trigger § 47; there was no disposition of Section 38 property, than calendar years, it would not make an intent test a less plausible and thus no ITC recapture. See Treas. Reg. § 1.1502- inference—a taxpayer intending to transfer § 47 assets out of the 3(f)(2)(i). Commissioner argues that even if this is the correct consolidated group would could still undertake the same series of transactions in the sam e allegedly nefarious sequence. T he reference to “calendar years” as opposed to “the order of events” indicates nothing abo ut whether the C omm issioner meant to inco rporate an intent test. 12 Commissioner’s position is also inconsistent with the notion that The Commissioner’s choice of lang uage, howe ver, tells us much the entity with the ability to keep the Section 38 property in the more. If the Commissioner wanted an intent test, he could have used the app ropriate trade or business use should be the same entity that faces word “intent” in his exam ple. Sutherland also sup ports my interpretation. recapture if it fails to do so . It may be mo re efficient to have the See, e.g., 2A N O R M A N J. S INGER , S U T H ER LA N D S T A TU T ES A N D taxpaying party be the one that holds the assets rather than force the S TATUTORY C O N S TR U C TIO N § 46.06 at 135 (2000 ed.) (“W hat a transferor to attempt to guarantee their future use ex an te by contract, legislature says in the text of a statute is considered the best evidence of since the property-holder (transferee) ca n more easily adap t to changes in the legislative intent or will.”); S INGER , supra, § 47:23 at 304-06 its economic circumstances over the relevant life of the Section 38 (explaining that the doctrine of expressio unius est exclusio alterius material. Notably, this case is not about whether a tax gets paid, but who indicates “an inference that all omissions should be understood as will pay it—the transferee or the transferor. Thus, siding with Taxpayer exclusions”). will not necessarily encourage tax avoidance. No. 01-2741 Aeroquip-Vickers v. Commissioner 37 38 Aeroquip-Vickers v. Commissioner No. 01-2741

interpretation of § 1.1502-3(f)(2)(i), the initial transaction recapture obligations remained, although now assigned to a became relevant for § 47 purposes when LOF Glass left the different party. LOF-affiliated group because the parent (LOF) no longer retained interest in the Section 38 property. IV.

In April of 1986, LOF Glass split-off from the LOF Commissioner also argues that the interpretation of affiliated group in the “D” reorganization with the exchange § 1.1502-3(f)(2)(i) contained in Rev. Rul. 82-20 is consistent of LOF Glass shares for Pilkington’s interest in LOF. This with the “step-transaction doctrine.” Commissioner notes that occurred immediately after LOF made LOF Glass an the “incidence of taxation depends upon the substance of a independent subsidiary, but the parties stipulated that LOF transaction,” rather than its form. Comm’r v. Court Holding Glass continued to use the Section 38 property in the glass Co., 324 U.S. 331, 334 (1945); see also Kluener v. Comm’r, business both before and after LOF Glass left the consolidated 154 F.3d 630, 634 (6th Cir. 1998). “The step transaction group. When LOF Glass left the group, it did so subject to doctrine is a judicial device expressing the familiar principle the transferee obligation for the ITC recapture that arose when that in applying the income tax laws, the substance rather than it received the Section 38 property along with the LOF Glass the form of the transaction is controlling.” Brown v. United Division business initially. See Treas. Reg. § 1.1502- States, 782 F.2d 559, 563 (6th Cir. 1986) (internal quotations 3(f)(2)(i). omitted). Under this doctrine, “interrelated yet formally distinct steps in an integrated transaction may not be Although Commissioner argues, in accordance with Rev. considered independently of the overall transaction.” Rul. 82-20, that these intra-group transfers and the “D” Comm’r v. Clark, 489 U.S. 726, 738 (1989). Although reorganization evince an intent to avoid ITC recapture by various courts have applied different tests to determine disposing of the property outside of the group, the worst the whether the step-transaction doctrine applies in a particular transactions show is nothing more than a shift in ITC case, this Court uses the “end result” test. Brown, 782 F.2d recapture liability.13 By transferring the LOF Glass Division at 564. Pursuant to the “end result” test, “purportedly and the Section 38 property within the consolidated group, the separate transactions will be amalgamated into a single parties imposed liability for the ITC recapture on LOF Glass. transaction when it appears that they were really component When Pilkington acquired LOF Glass—albeit one day parts of a single transaction intended from the outset to be later—LOF Glass brought with it the same ITC recapture taken for the purpose of reaching the ultimate result.” Id. obligation. If LOF Glass became a member of a Pilkington (internal quotation marks omitted). consolidated group, then that consolidated group would be subject to ITC recapture as well. See Treas. Reg. § 1.1502- The appeal of step-transaction analysis rapidly dissipates 3(f)(2)(i). Under the consolidated return regulations, the ITC when one remembers that Commissioner stipulated that the transaction appropriately received “D” reorganization treatment, which means Commissioner stipulated, inter alia, that the split-off transaction was “not used principally as a 13 device for the distribution of the earnings and profits” of LOF And it is not necessarily an intentional shift, since Commissioner stipulated that the reorganization was “not used principally as a device for or LOF Glass. See I.R.C. § 355(a)(1)(B). The Commissioner the distribution of the earnings and profits of LOF or LOF Glass.” (See thus conceded that LOF and LOF Glass were engaged in the J.A. at 57.) The Co mmissioner’s stipulation is discussed m ore tho roughly “active conduct of a trade or business” for at least five years in conjunctio n with the step-transaction issue be low. No. 01-2741 Aeroquip-Vickers v. Commissioner 39 40 Aeroquip-Vickers v. Commissioner No. 01-2741

prior to the transaction and for five years after Pilkington masquerading as a corporate reorganization, and nothing became the owner of LOF Glass. See I.R.C. § 355(a) and (b). else.’ Gregory v. Helvering, 293 U.S. 465, 470 (1935) If the transfers from LOF Glass Division to LOF Glass and (emphasis added).” By emphasizing “and nothing else,” the ultimately to Pilkington had economic viability (and thus majority implies that, despite the government’s stipulation, were not merely tax avoidance transactions), then the step- both a legitimate business purpose and an improper tax transaction doctrine cannot apply. See Rev. Rul. 79-250, avoidance objective motivated the disputed transaction. The 1979-2 C.B. 156, 157 (explaining that where each step in a majority then cites a Tenth Circuit case, Associated corporate reorganization has an independent legal and Wholesale Grocers, Inc. v. United States, 927 F.2d 1517, economic significance, the step-transaction doctrine does not 1526 (10th Cir. 1991), for the general proposition that a apply). taxpayer may not dodge provisions of the tax code merely because the taxpayer can articulate some business purpose for The majority cites no authority for the proposition that the its activity. In the present dispute, however, Taxpayer offers IRS can accept an entire transaction as justified by a this Court much more than a general assurance that it had a legitimate business purpose to determine whether “D” business purpose for its transaction.15 reorganization treatment will apply, but not accept a part of that same transaction as motivated by a legitimate business Again, the Commissioner stipulated that the transaction purpose exclusively to determine ITC recapture—particularly properly received “D” reorganization treatment, which means given that the “substance over form” principle requires courts Commissioner stipulated, inter alia, that the split-off to view transactions “as a whole, and each step, from the transaction was “not used principally as a device for the commencement of negotiations to the consummation of the distribution of the earnings and profits” of LOF or LOF sale, is relevant.”14 Court Holding, 324 U.S. at 334. Glass. See I.R.C. § 355(a)(1)(B) (emphasis added). The phrase “a device for the distribution of . . . earnings and The majority further concedes, as it must, that this case profits” means simply “a device for the distribution of . . . does not involve a situation where “‘[t]he whole undertaking earnings and profits [so as to avoid taxes].” Id. Put . . . was in fact an elaborate and devious form of conveyance differently, the Commissioner conceded that the split-off was not principally a tax avoidance mechanism. The majority’s Tenth Circuit step-transaction case does not involve any 14 One sentenc e drafted by the majority deserves particular attention. stipulation by Commissioner—let alone a concession that the The majority claims, without citation, that “[h]ere, although the individual taxpayer’s transaction did not principally serve a tax- steps of the transaction had a legitimate business reason, the transaction avoidance purpose. must be treated as a single unit and judged by its end result.” I have no idea how a party could possibly intend several steps to achieve various Moreover, in Rev. Rul. 79-250, 1979-2 C.B. 156, the legitimate business purposes but simultaneously intend the series of steps Commissioner conceded that in § 368 situations like this one, to accomplish an illegitimate tax-avoidance objective. As a matter of logic, if an agen t undertakes a series of related acts, and if each step is viewed as part of a process intended to achiev e an legitimate goal, it is 15 impo ssible to view all steps as intending to serve illegitimate ends. In fact, the Associa ted Gro cers court “share[d] the government’s Somewhere along the line, the agent must have intended at least one of the skepticism as to the alleged significance of taxpayer’s claimed business steps to acco mplish something im proper (in this case, without a legitimate purp ose.” 927 F.3d at 1527. Associa ted Gro cers also involved a business purpose). Commissioner concedes Respondent acted with a com pletely different statutory provision—a liquidation under I.R.C . § 332 business purpose at every stage. rather than a § 368 restructuring. Id. at 1519. No. 01-2741 Aeroquip-Vickers v. Commissioner 41

the step-transaction doctrine would not apply. According to the Commissioner, “the substance of each of a series of steps will be recognized and the step transaction doctrine will not apply, if each such step demonstrates independent economic significance, is not subject to attack as a sham, and was undertaken for valid business purposes and not mere avoidance of taxes.” (emphasis added). This seems to resolve the matter, and the majority has no rational reason to defer to Rev. Rul. 82-20 at the expense of Rev. Rul. 79-250. V. More than two decades ago, this Court correctly observed that the Treasury Department’s consolidated return regulations should receive greater deference than interpretations of those regulations. See Wolter Constr. v. Comm’r, 634 F.2d 1029, 1034-35 (6th Cir. 1980). This principle unquestionably applies here. It seems either very difficult or impossible for an interpretive statement to survive Skidmore review when that statement conflicts with the text it purports to interpret. Commissioner’s Revenue Ruling is not persuasive because it contradicts the text and examples in § 1.1502-3(f). For all the aforementioned reasons, I respectfully dissent.