Legal Ruling 1964-264

Franchise-Doing Business: Litigation by Liquidating Corporation

Prosecuting a collection claim and resisting a claim for damages based on activities during prior years does not constitute doing business.

In 1956, the shareholders of the taxpayer adopted a plan of complete liquidation, providing for the liquidation and dissolution of the company. As of 1957, the taxpayer had distributed all of its assets to its shareholders in complete liquidation except for certain funds retained in a bank account to meet claims.

In 1954, the taxpayer had entered into a written contract with A Company to furnish materials and equipment for certain dredging work. The taxpayer performed all of the work it deemed required under the contract by 1956.  At that time a balance of$40,000 was due on the contract price. A dispute arose between the parties on the performance of the contract, and A Company refused to pay the balance. Consequently, the matter was then referred to the taxpayer's attorneys for collection, and suit was filed in 1957. Some time in 1957, an answer to this complaint was filed; and at the same time A Company filed a cross-complaint alleging that the work had been improperly and incompletely performed, with resulting damage by reason of loss of use of the property. An answer to this cross-complaint was filed by the taxpayer in 1957. Thereafter, the case was given a trial date for 1958. The case was then reset for trial in 1959.

In 1959, the case was settled without trial. As a result of the settlement, the taxpayer received $10,000 on its claim, and the cross-complaint against it was dismissed. The taxpayer's return for the income year 1957 stated that the corporation is dissolved and will not be doing business in 1958, and the minimum tax of $25 was self-assessed and paid.

Does litigation by a liquidating corporation over claims arising from prior business activities constitute "doing business"?

Section 23101 defines "doing business" to mean "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit." The section has been construed a number of times in respect to the activities of corporations in liquidation. As a result, it is well established that the collection of accounts receivable that are not interest-bearing does not constitute doing business. Appeal of Johnson Foundry & Machine Co., State Board of Equalization, November 17, 1948; Legal Memo #37, November 8, 1950; Legal Memo #118, July 24, 1951; Legal Memo #119, July 24, 1951; Legal Memo #157, May 22, 1952.

In the instant situation the taxpayer is not engaged in merely collecting a settled account but, rather, is engaged in litigation to establish the validity of its claim and to resist a counter suit for damages. However, the determining fact would seem to be that all of the activities or transactions which gave rise to the earning of income took place in prior years.  The performance was completed and the profit, if any, was realized prior to 1958. The litigation, to establish whether a valid claim exists, determines only whether a profit was in fact earned in the prior period. Although the settlement or collection of a controverted claim may, in a sense, be considered an economic benefit, the efforts to establish a claim or the settlement of an uncertain account, arising from prior activities or events, have not themselves been considered to be transactions for financial or pecuniary gain or profit. In Appeal of Johnson Foundry & Machine Co., supra, it was held that filing a claim for relief from a tax was not in the nature of a transaction entered into for pecuniary gain because, if allowed, it would only restore that which rightfully belonged to the taxpayer before the claim was filed. Similarly, any recovery by the taxpayer in the instant situation would only give it that which rightfully belonged to it before the litigation began. It has previously been concluded that settling disputed accounts was not "doing business." Likewise, the prosecution of Federal tax claims and the determination of the ultimate amount of contingent notes receivable were considered not to be "doing business." It follows that prosecuting the recovery of an alleged account receivable or settling upon the amount due does not constitute "doing business."

For the same reasons it must also be concluded that resisting a claim for damages based on activities engaged in during prior years does not constitute "doing business." The situation is identical except that the parties are in opposite positions, and as to the instant taxpayer it involves the settlement of an alleged liability rather than a receivable.