SCOTUS Reports

Tag: IRC Section 341

  • Computer Sciences Corp. v. Commissioner, 63 T.C. 327 (1974): When Intangible Assets Constitute ‘Property’ Under Collapsible Corporation Rules

    Computer Sciences Corp. v. Commissioner, 63 T. C. 327 (1974)

    Intangible assets, such as computer programs and copyrighted forms, can be considered ‘property’ produced by a corporation under the collapsible corporation rules of IRC Section 341.

    Summary

    Computer Sciences Corp. (CSC) developed a proprietary computer program for tax return preparation and transferred it to its subsidiary, Computax. The IRS argued that Computax was a collapsible corporation under IRC Section 341 because CSC sold stock in Computax before substantial income was realized from the program. The Tax Court held that the program was intangible property produced by CSC, but the production was complete before CSC formed a view to sell Computax stock, thus Computax was not a collapsible corporation. This ruling clarifies that intangible assets can be ‘property’ under Section 341, but the timing of when the production of such property is considered complete is crucial for determining collapsible corporation status.

    Facts

    CSC, a computer services company, developed a proprietary computer program for tax return preparation in 1963 to utilize its UNIVAC 1107 computer. After initial losses, CSC expanded the program’s capabilities. In June 1965, CSC formed Computax Corp. as a wholly owned subsidiary and transferred the program to it. By September 1965, CSC sold a controlling interest in Computax to Commerce Clearing House (CCH) for $4. 3 million. The IRS asserted that Computax was a collapsible corporation under IRC Section 341, treating CSC’s gain from the stock sale as ordinary income.

    Procedural History

    The IRS determined a deficiency in CSC’s federal income tax for the fiscal year ended April 1, 1966, treating the gain from the Computax stock sale as ordinary income under Section 341. CSC petitioned the Tax Court for a redetermination. The court heard the case and issued its decision on December 16, 1974.

    Issue(s)

    1. Whether the computer program developed by CSC constitutes ‘property’ within the meaning of IRC Section 341.
    2. Whether CSC formed or availed of Computax with a view to selling its stock before a substantial part of the taxable income from the program was realized.

    Holding

    1. Yes, because the program and related forms are intangible assets that meet the definition of ‘property’ under Section 341.
    2. No, because the production of the program was complete by mid-April 1965, before CSC formed the view to sell Computax stock.

    Court’s Reasoning

    The court reasoned that the computer program and copyrighted forms were intangible property produced by CSC, as Section 341 does not limit ‘property’ to tangible assets. The court applied the rule that a corporation is collapsible if it is formed or availed of with a view to selling its stock before realizing substantial income from the produced property. The court found that CSC’s view to sell Computax stock was formed no earlier than April 19, 1965, after the program’s production was complete. The court defined ‘production’ as completed when the program was ready for commercial use, which occurred by mid-April 1965. The court distinguished this from ongoing improvements made during commercialization, which do not affect the completion of production for Section 341 purposes.

    Practical Implications

    This decision establishes that intangible assets can be treated as ‘property’ under the collapsible corporation rules, expanding the scope of Section 341. For practitioners, it is crucial to determine when the production of an intangible asset is complete, as this affects whether a corporation can be considered collapsible. The ruling suggests that once an intangible asset is ready for commercial use, its production is considered complete, even if further improvements are made. This case may influence how companies structure the development and transfer of intellectual property to subsidiaries, particularly in technology and software industries. Subsequent cases have cited this decision when analyzing the collapsible corporation status of entities involved in intangible asset development.

  • F.T.S. Associates, Inc. v. Commissioner, 58 T.C. 207 (1972): Definition of Collapsible Corporation Under IRC Section 341

    F. T. S. Associates, Inc. v. Commissioner, 58 T. C. 207 (1972)

    A corporation is not collapsible under IRC Section 341 if the intent to liquidate arises after the cessation of business activity and not during the manufacture or production of the property.

    Summary

    F. T. S. Associates, Inc. developed a disposable toothbrush but failed to generate sales. Facing insolvency, it sold its assets and liquidated. The IRS argued F. T. S. was a collapsible corporation under IRC Section 341, subjecting its gains to tax. The Tax Court held that F. T. S. was not collapsible because the intent to liquidate arose after the business ceased operations, not during the product’s development, allowing the corporation to exclude the gains under IRC Section 337.

    Facts

    F. T. S. Associates, Inc. was incorporated in 1962 to develop and market a disposable toothbrush named “Tush. ” After unsuccessful marketing efforts in the Boston area in 1965, the company faced insolvency. In October 1965, F. T. S. sold all its assets to Oscar Alvareztorre for $205,000 and adopted a plan of liquidation. The company realized a gain of $145,968. 24 from the sale, which it elected to exclude from taxable income under IRC Section 337.

    Procedural History

    The IRS determined a deficiency in F. T. S. ‘s 1965 income tax, arguing that F. T. S. was a collapsible corporation under IRC Section 341, which would render the nonrecognition provisions of Section 337 inapplicable. F. T. S. petitioned the U. S. Tax Court, which ruled in favor of F. T. S. , holding that it was not a collapsible corporation.

    Issue(s)

    1. Whether F. T. S. Associates, Inc. is a “collapsible corporation” as defined in IRC Section 341(b)(1).

    Holding

    1. No, because the intent to liquidate and sell the assets arose after the cessation of business activity, not during the manufacture or production of the product.

    Court’s Reasoning

    The court analyzed the definition of a collapsible corporation under IRC Section 341(b)(1), which requires that the corporation be formed or availed of principally for manufacturing property with a view to selling stock or distributing property before realizing taxable income from such property. The court emphasized that the intent to liquidate must exist during the time of manufacturing or production, not after business cessation. In this case, F. T. S. did not have the requisite intent during the development and initial marketing of Tush. The intent to liquidate arose only after the failure of the Boston campaign and the subsequent insolvency, which was after the cessation of business. The court accepted the IRS’s regulation that the proscribed intent must exist during the manufacturing phase, not merely at the time of liquidation. Therefore, F. T. S. was not a collapsible corporation, and the gains from the asset sale were properly excluded under IRC Section 337.

    Practical Implications

    This decision clarifies that the timing of intent to liquidate is critical in determining whether a corporation is collapsible under IRC Section 341. For similar cases, attorneys should focus on when the intent to liquidate arose relative to the business operations. This ruling encourages careful planning of corporate liquidations to avoid unintended tax consequences. Businesses contemplating liquidation should document the timing and circumstances leading to the decision to liquidate, especially if they face financial difficulties after unsuccessful business ventures. Subsequent cases have followed this principle, reinforcing the importance of timing in the application of the collapsible corporation provisions.