Legal Ruling 1965-288

Franchise-Subsidiaries Corporations: Intercorporate Payments After Commencement of Liquidation

Payments by subsidiary corporations to their parent after the commencement of liquidation are to be treated as a distribution in liquidation within the meaning of Section 24501, Revenue and Taxation Code.

X Corporation had an ownership interest of 80 percent in a number of corporations. Agreements were entered into by X and its subsidiaries for the filing of a Federal consolidated income tax return for the group. The agreements provided that each subsidiary would pay to the parent an amount equal to that which each would have been required to pay if a separate Federal income tax return were filed. X paid the consolidated income tax liability, and, in the particular years involved, retained an excess received under the agreements over the liability disclosed by the consolidated return.

A number of these subsidiary corporations sold their assets, and subsequently the shareholders of each adopted plans of liquidation. The liquidations came within the provisions of Section 24502 of the Bank and Corporation Tax Law, providing for nonrecognition of gain or loss on the liquidation of certain subsidiary corporations.

During the years prior to 1956, these corporations made payments to X pursuant to the consolidated tax agreements. The payments were made after the respective corporations had adopted a plan of liquidation.

How is the payment made by the subsidiary after it has commenced liquidation to be treated by the parent?

There is agreement that any excess received by a parent corporation over a subsidiary's allocable share of the consolidated tax liability is to be treated as an ordinary dividend, where paid in the ordinary course of business with intent to maintain the subsidiary as a going concern. See Section 24495, defining "dividend"; also, Beneficial Corp., 18 T.C. 396 aff'd per cur. 202 Fed. 2d 150 43 AFTR 282.

Section 24501 provides that amounts distributed in liquidation of a corporation shall be treated as in full payment in exchange for stock. Inasmuch as, in this case, the subsidiaries have commenced liquidation proceedings, it is concluded that the payments made thereafter are governed by this section.

The view has been expressed that the payments, even though made after liquidation has commenced, should not be treated as distributions in liquidations, because they arise under an agreement entered into prior to the adoption of the plan of liquidation. It is contended that, by reason of the obligation created by the prior agreement, the payments retain their nature as ordinary dividends. This view does not appear to be supportable. Although the agreement creates an obligation to make the payment, it does not, per se, determine the treatment of the payment. Although no case directly in point has been found, a number of cases tend to support the conclusion that, once liquidation proceedings have been commenced or a course of liquidation has been clearly decided upon, the fact of liquidation is controlling, and all subsequent payments are treated as distributions in liquidation and not as ordinary dividends. Texas Empire Pipe Line Co. v. Com., 127 Fed. 2d 220; Holmby Corp. v. Com., 83 Fed. 2d 548; Canal-Commercial T. & S. Bank v. Com., 63 Fed. 2d 619; Herbert A. Nieman & Co. 33 T.C. 451; Arthur Letts, Jr., 30 BTA 800; Cf.Tate v. Com., 97 Fed. 2d 658; Virginia Ice and Freezing Corp., 30 T.C. 1251.

Furthermore, support for the conclusion reached herein, that the prior agreement is not controlling, is found in cases holding that in the particular circumstances various events or conditions occurring prior to payment are not controlling with respect to the dividend. For example, the declaration of a dividend does not constitute a distribution of the dividend, there being no realization until subsequently paid, Mason v. Routzahn, 275 U.S. 175; the source of the dividend, whether from earnings and profits, is determined not as of the date of declaration when the debtor and creditor relationship is created between the corporation and the stockholder but as of the date of payment, Emily D. Proctor, 11 BTA 235; see Com. v. American Light & Traction Co., 156 Fed. 2d 398; and, the prior accrual of a reserve for patronage dividends payable, which is subject to contingent charges, was held not to be income to members of the cooperative, Farmers Grain Dealers Assn. of Iowa v. U.S., 116 Fed. Supp. 685. In Beneficial Corporation, 18 T.C. 396, a case involving a payment similar to that herein, the court rejected the taxpayer's contention that the transaction "accrued" in the tax year for which the consolidated return was filed and should not be taken into account the following year when the payment was made by the subsidiary to the parent. The court stated that there was no question of any accrual of a liability; and, that the transaction was governed by the rule covering includibility of a dividend distribution. The foregoing cases, although not directly on the question herein, are relevant in that they tend to discount the significance of actions, conditions, or events preceding the time of distribution, and, rather, stress the importance of considering the facts and circumstances existing at the time the payment is made.

Also of some general support for the conclusion reached are those cases considering the date on which a dividend is properly includible by the recipient. The rule is established that dividends are includible when received, whether the recipient is on the cash or the accrual basis. Avery v. Com., 292 U.S. 210; Tar Products Corp. v. Com., 130 Fed. 2d 866; Com v. American Light & Traction Co., 156 Fed. 2d 398.