Spaulding Bakeries Incorporated, Petitioner, v. Commissioner of Internal Revenue, Respondent, 27 T.C. 684 (1957)

A parent corporation is entitled to a worthless stock deduction when a subsidiary’s liquidation results in asset distributions that satisfy only the preferred stock claims, leaving nothing for the common stock held by the parent.

Summary

Spaulding Bakeries, Inc. (the parent) owned all the stock of Hazleton Bakeries, Inc. (the subsidiary), which included both common and preferred stock. Upon the subsidiary’s liquidation, the assets were insufficient to cover the preferred stock’s liquidation preference. The IRS disallowed Spaulding’s deduction for the loss on its worthless common stock, arguing that Section 112(b)(6) of the 1939 Internal Revenue Code, which concerns non-recognition of gain or loss in certain liquidations, applied. The Tax Court held that Section 112(b)(6) did not apply because there was no distribution to the parent on its common stock. The preferred stock claim absorbed all the assets, and thus, Spaulding was entitled to the worthless stock deduction.

Facts

Spaulding Bakeries, Inc. purchased all outstanding common stock and most of the preferred stock of Hazleton Bakeries, Inc. Hazleton was dissolved in 1950. The liquidation plan distributed the subsidiary’s assets to the parent. The subsidiary’s certificate of incorporation provided that in liquidation, preferred stockholders would be paid in full, with any remaining assets distributed to common stockholders. The assets of Hazleton at the time of liquidation were insufficient to cover the liquidation preference of the preferred stock. The parent corporation claimed a worthless stock deduction for the loss on its common stock.

Procedural History

The Commissioner disallowed the claimed worthless stock deduction. The Tax Court heard the case, and issued a decision in favor of Spaulding Bakeries, Inc. The Commissioner appealed the decision, but it was not heard. The Tax Court decision stands.

Issue(s)

1. Whether a parent corporation can claim a worthless stock deduction for its common stock in a subsidiary when the subsidiary’s assets are insufficient to satisfy the liquidation preference of the preferred stock, and therefore, nothing is distributed on the common stock.

Holding

1. Yes, because there was no distribution to the parent on its common stock in the subsidiary liquidation.

Court’s Reasoning

The court analyzed whether I.R.C. § 112(b)(6) applied. The court noted that the statute would prevent the loss from being recognized if there was a distribution of assets upon liquidation. However, the court determined that there was no distribution to the parent as a common stockholder. The court reasoned that the statute requires a distribution to a stockholder as such, and that since all assets were distributed to the preferred shareholders, there was no distribution with respect to the common stock. The court also cited cases where a parent was also a creditor, holding that a parent could take a bad debt and stock loss deduction where the distribution in liquidation was insufficient to satisfy more than a part of the debt. The court quoted C. M. Menzies, Inc., 34 B.T.A. 163, 168, which stated that “The liquidation of a corporation is the process of winding up its affairs, realizing its assets, paying its debts, and distributing to its stockholders, as such, the balance remaining.” The court emphasized that the statute makes no distinction between the classes of stock. Since nothing was distributed to Spaulding as a common stockholder, the court held that the deduction should be permitted.

Practical Implications

This case is important for parent corporations with subsidiaries. The court clarifies that a worthless stock deduction can be taken when a liquidation results in a distribution that only satisfies the preferred stock claims. This impacts how tax advisors and corporate attorneys analyze liquidation scenarios. When structuring liquidations of subsidiaries, tax professionals must consider the allocation of assets to different classes of stock. This case is still good law.