Union Bankers Insurance Company, Appellant, v. United States of America, Appellee, 317 F.2d 598 (5th Cir. 1963)

The question presented is whether there is a vicarious transfer subject to the stamp tax under § 4321¹  when the stock issued by the Surviving Corporation as payment for the assets acquired from the Absorbed Company is rateably distributed directly to the stockholders of the Absorbed Company rather than to it for redistribution in liquidation. While the unsuccessful Taxpayer perhaps challenges the entire notion that a taxable transfer ever takes place in a statutory merger, that battle is an uphill one, and so far, the law is pretty much against it. All going back to the wellspring, Raybestos-Manhattan Co. v. United States, 1935, 296 U.S. 60, 56 S. Ct. 63, 80 L. Ed. 44, at least two decisions involving classic statutory mergers hold there is a theoretical transfer,²  as do a number of others concerned with intracorporate successor rearrangements³  and our two very recent cases of unquestioned authority and correctness relating to the transfer of all assets of a fund-raising corporation in exchange for the stock of a newly created Texas life insurance corporation.⁴  The theory, broadly stated, is that when a corporation in situations of this kind transfers its assets, it alone is entitled to receive the stock issued by the acquiring (Surviving) corporation, and its direction to distribute the stock to another (its own stockholders) is, in practical effect, the equivalent of its having first received the stock and then redistributed it to stockholders. Faced with this formidable historical development, the Taxpayer wisely narrows the attack. Its contention essentially is that by virtue of Texas Statutes regulating life insurance companies — including their merger — the Absorbed Company had no right to receive the stock issued by the Surviving Corporation, and hence there was no transfer of the Raybestos-Manhattan type. We agree and reverse.

The underlying facts (all of which were stipulated before the District Court) may be severely capsulated for our purposes. Guaranty National⁵  and Southwest American⁵ were two separate corporations engaged in the life insurance business in Texas. The two were substantially owned by the same controlling stockholders. After proper stockholder action under Texas law, Guaranty National and Southwest American entered into a Merger and Consolidation Agreement.⁶  This Agreement made April 3, 1956, was formally approved by the Board of Insurance Commissioners as required by Texas law. Texas, as is generally true elsewhere, severely regulates life insurance companies. Under the Agreement, Guaranty National was to be the Absorbed Company and Southwest American was to be the Surviving Corporation. All of the assets of the Absorbed Company were to be transferred to the Surviving Corporation in exchange for specified amounts of its stock to be issued directly to the stockholders of the Absorbed Company. After approval by the State authorities, the transaction was carried out. The Surviving Corporation took over all of the assets of the Absorbed Company, assumed all of its liabilities as the Insurance Code prescribed, and over a period of time (1956-57) issued 2,047,817 shares of its previously authorized capital stock directly to the stockholders of the Absorbed Company. None of the certificates evidencing ownership of the 2,047,817 shares of stock was actually issued to the Absorbed Company. The documentary stamp tax imposed by § 4301 on the original issuance of this stock by the Surviving Corporation was paid, and no question exists as to it. The Commissioner, however, determined that the transfer of its assets by the Absorbed Company to the Surviving Corporation in return for the issuance by it of stock to the Absorbed Company's stockholders constituted the transfer by the Absorbed Company to its own stockholders of its right to receive the stock of the Surviving Corporation.⁷ 

At the outset, we do not regard this case as posing any real question of supremacy of federal over Texas law. The parties are in essential agreement on it. Local law is important.⁸  But in the final analysis whether the transaction, valid as it is under Texas law, constitutes a transfer within the meaning of this revenue measure is a federal question. The controlling and federal question is whether or not a particular interest or right was the object intended to be taxed. Morgan v. Commissioner, 1940, 309 U.S. 78, 80, 81, 60 S. Ct. 424, 84 L. Ed. 585.

With that approach, it is helpful to consider the Supreme Court's description of the purpose and reach of this Act. Because not directly involved as it is here, these words perhaps have been obscured in former decisions by the continual reliance on those portions which we have so recently re-emphasized.⁹  Basic to our problem, the Court stated:

"The stock transfer tax is a revenue measure exclusively. Its language discloses the general purpose to tax every transaction whereby the right to be or become a shareholder of a corporation or to receive any certificate of any interest in its property is surrendered by one and invested in another." 296 U.S. 60, 62, 56 S. Ct. 63, 64, 80 L. Ed. 44.

Translating that in terms of this case, if the Absorbed Company had "the right to be or become a shareholder" in the Surviving Corporation "or to receive any certificate of any interest in its property", then surrendering that to vest in another (the Absorbed Company stockholders) is a taxable transfer. Conversely, if the Absorbed Company did not have that right, then the issuance of stock direct to its stockholders does not amount to a transfer. In that situation there would have been no bypass.

Actually this is also implicit in the more frequent quotations (see note 9, supra). If it is borne in mind that Congress seeks only to tax transfers of stock, then it is clear that when the Court speaks of the "generating source" being the "conveyance * * * of the property" for which new shares "could not lawfully be issued" to one other than the Absorbed Company without its authority, it is discussing matters of nonfederal law. In other words, it is within the competence of the local law alone¹⁰  to determine the circumstances under which assets of incorporated entities may be transferred and how and in what manner the consideration therefor is to, or may, be paid. In every case so far (see notes 2, 3, and 4), the Court in finding a taxable transfer was justified in holding on the basis of the pertinent local law that the Absorbed Company had the right to receive and hence the right to direct the disposition of stock issued in payment for assets.¹¹ 

This brings us face-to-face with Texas law. Does Texas permit a life insurance company "to be or become" a stockholder of another life insurance company? Does Texas permit a Texas life insurance company "to receive any certificate" of ownership in the property of another life insurance company? The negative answers to these and related matters are emphatic.

First, as to investments, the Texas Insurance Code through a combination of negative prohibitions and affirmative authorizations rigidly confines ownership of stock of another life insurance company to a small portion of its "capital, surplus and contingency funds" in a comparable small portion of the capital stock of another insurance company whose "principal business is the reinsurance * * * of risks ceded to it" by others. No others are permitted.¹²  This strong policy against pyramiding ownership in life insurance companies through the obvious process of mergers or consolidations is carefully preserved by restrictions of what companies may consolidate (see note 6, supra) and the manner in which such consolidation is to be carried out and the consideration paid for the assets transferred. Thus no such consolidation may take place until "at least two-thirds of the capital stock of each of the companies shall vote in favor thereof at a separate meeting of the stockholders of each company called for such purpose." Art. 21.25. And if stock of the Surviving Corporation is to be used as payment for the assets transferred, the Insurance Code carefully confines the issuance of such stock "to the stockholders of * * * the companies consolidated."¹³ 

Indeed, these Texas policy strictures against ownership momentary or permanent, of stock in another life insurance company are made manifest by events occurring subsequent to the time (1956-1957) of these transactions. There have been major amendments to Art. 21.25 and 21.26, the most notable, for our purposes, being an express statutory recognition that prior to these amendments, Art. 3.39 — meant exactly what it said — the acquisition of the stock of one life insurance company by another life insurance company was positively forbidden.¹⁴ 

While the Taxpayer emphasized as the critical thing that it is the action of the stockholders, initiated in special meetings called for such purpose, the result of which presumably might freeze out dissident stockholders, we do not base our conclusion on that. Important as is the action of the stockholders, the fact that the two corporations through their respective Boards of Directors and Officers were to, and did, take important action does not alter our view. Paraphrasing the Supreme Court, one might even assume that in this particular case the Merger and Consolidation Agreement and the corporate action of each of the two companies to effectuate it was "the generating source of the right to receive the newly issued shares of" the Surviving Corporation. For it must be remembered that Congress did not undertake by § 4321 to tax the initiation and execution of transactions which brought about the exchange of assets of one corporation for newly issued stock of another.¹⁵  All we are concerned with is a transfer of any stock after issuance by the Surviving Corporation. Without a doubt, corporate action of an essential and effective kind was taken by each through instrumentalities other than stockholders as such. But there is a transfer subject to the stamp tax only if, under the law of Texas, in the execution of that corporate devised plan for exchange of assets for stock, the Absorbed Company had the right to acquire such shares of stock and, having such right, it chose to direct their disposition of stock to others.

Since under Texas law the Absorbed Company had no such right and for it to have acquired such shares even momentarily would have violated a sharply defined policy of Texas, the transaction may not in this unusual situation be viewed as though the stock was first received and then redistributed.¹⁶ 

Reversed.