United States v. Hendler
Headline: Court narrows reorganization tax exemption and rules a merging company’s payment of the target’s debts counts as taxable gain to the target, making corporations pay tax on debts discharged in mergers.
Holding: When one corporation assumes and pays another’s debt under a reorganization plan, the discharged debt is taxable gain to the company whose liability was paid because it was not received as stock or distributed to shareholders.
- Makes debt payments in mergers taxable as income to the company whose debts are discharged.
- Prevents companies from avoiding tax by having acquirers pay their creditors without distributing money to shareholders.
- Reverses lower courts’ rulings, increasing tax liabilities in similar reorganizations.
Summary
Background
The dispute involves the Borden Company and the Hendler Creamery Company, Inc. They underwent a merger or reorganization that generated more than six million dollars in gains for Hendler. Under the 1928 Revenue Act, §112, some gains in reorganizations can be exempt if property is exchanged solely for stock or if money or property received is distributed to stockholders. As part of the plan, Borden assumed and paid $534,297.40 of Hendler’s bonded indebtedness. Lower courts concluded that the Hendler gains were non-taxable under §112, and the Court of Appeals affirmed the district court. Two Justices took no part in the decision.
Reasoning
The core question was whether the payment by Borden of Hendler’s debt should be treated as money received and distributed under the reorganization exemption. The Court said the transaction must be viewed in substance as if Hendler had received the $534,297.40 and then had its debt paid; that discharge of liability produced real income to Hendler. Because the gain was neither received as stock or securities nor distributed to Hendler’s stockholders under the plan, it did not fall within §112’s exemptions. The Court cited the statute’s wording and prior explanation that the exemption contemplates distributions to stockholders, not payments to creditors, and reversed the lower courts.
Real world impact
The ruling means companies cannot avoid tax on gains by structuring a merger so a purchaser simply pays off the target’s creditors without distributing the money to shareholders. Corporations and tax administrators will treat discharged debt in similar reorganizations as taxable income to the company whose liability was removed.
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