Decisions will be entered for the respondent.
1. Corporations A, B, and C, organized under the laws of California, Illinois, and New York, respectively, carried on separate but related businesses in different parts of the United States. A, B, and C were merged into a new corporation, D, organized under the laws of New Mexico. A, B, C, and D had the same sole stockholder and the same officers; and the businesses formerly conducted by A, B, and C were carried on by D in the same manner as before the merger. Held, the fusion of A, B, and C into D was not a "mere change in identity, form, or place of organization" within the meaning of sec. 368(a)(1)(F) of the 1954 Code, with the result, first, that A, B, and C were required to file closing returns for the taxable period ending at the time of the merger under sec. 381(b)(1), and second, that a subsequent net operating loss of D could not be carried back to a premerger year by reason of sec. 381(b)(3). Pridemark, Inc., 42 T.C. 510">42 T.C. 510, reversed 345 F. 2d 35 (C.A. 4), disapproved as to holding in respect of sec. 368(a)(1)(F).
2. A, B, and C each valued its inventories at the lower of cost or market. Held, the market values of such inventories *96 on the date of the merger were not in fact less than cost, and A, B, and C are not entitled to have their inventories on that date reduced below cost or book value.
3. Held, the erroneous refunds of A's taxes to D resulting from D's application under sec. 6411 for tentative allowance of a carryback of its post-merger net operating loss to A's premerger income resulted in deficiencies in A's taxes for such premerger years. Sec. 6211.
*278 These consolidated cases involve the liability of Bernard H. Stauffer as ultimate transferee of the assets of three corporations ("Stauffer California," "Stauffer Illinois," and "Stauffer New York"), in respect of which the Commissioner determined deficiencies in income tax as follows:
| Stauffer | Stauffer | Stauffer | |
| California | Illinois | New York | |
| Fiscal year ended Jan. 1, 1958 | $ 1,481,653.05 | ||
| Fiscal year ended Jan. 31, 1959 | 213,472.25 | ||
| 8-month period Feb. 1 to Sept. 30, 1959 | 412,021.19 | $ 340,822.82 | $ 6,943.95 |
The principal question is whether the absorption of these corporations by a new corporation ("Stauffer New Mexico") on October 1, 1959, was a reorganization *97 under section 368(a)(1)(F) of the 1954 Code with the consequence (a) that the taxable year of each of the three predecessor corporations was not required to end at that time pursuant to section 381(b)(1); and (b) that a subsequent net operating loss of the new corporation might be carried back to a tax year prior to the reorganization pursuant to section 381(b)(3). Other questions presented, in the event it is determined that no reorganization took place under section 368(a)(1)(F), are (1) whether there should be a downward revision of the value of the inventories of each of the three old companies as of September 30, 1959; and (2) whether the Commissioner properly determined deficiencies against Stauffer California for the fiscal years ended January 31, 1958 and 1959.
FINDINGS OF FACT
The stipulations of fact together with accompanying exhibits are incorporated herein by this reference.
The notices of deficiency in these cases were sent to Bernard H. Stauffer, determining his liability as the ultimate transferee of the assets of each of three corporations (hereinafter sometimes referred to collectively as the old Stauffer companies), namely, Stauffer Reducing, Inc., of California, a *98 California corporation (Stauffer California), Stauffer Reducing, Inc., an Illinois corporation (Stauffer Illinois), and Stauffer Reducing, Inc., of New York, a New York corporation (Stauffer New York). As more fully set forth hereinafter, *279 each of these corporations had transferred all of its assets to Stauffer Laboratories, Inc., a New Mexico corporation (Stauffer New Mexico), on October 1, 1959, and the assets of Stauffer New Mexico were thereafter transferred to Bernard H. Stauffer, its sole stockholder, on its liquidation on January 31, 1961. The transferee liabilities determined against Bernard H. Stauffer are based upon the deficiencies in income tax of the old Stauffer companies determined by the Commissioner. No notice of deficiency was ever sent to Stauffer New Mexico, or to Bernard H. Stauffer as transferee of a direct tax obligation of Stauffer New Mexico. No question of transferee liability is presented herein for decision, the only issue being whether the Commissioner correctly determined the deficiencies against the old Stauffer companies.
Bernard H. Stauffer died after issuance of the notices of deficiency. Letters testamentary were issued to his wife, Bonnie H. *99 Stauffer, and the petitions herein were thereafter filed by his estate. At all times relevant both husband and wife were residents of California.
Stauffer California filed Federal income tax returns for its fiscal years ended January 31, 1958 and 1959, with the district director of internal revenue at Los Angeles, Calif. No closing tax returns were filed by the old Stauffer companies for the period from February 1, 1959, to September 30, 1959, but Stauffer New Mexico filed a return for the entire fiscal year ended January 31, 1960, which included the operations of the old Stauffer companies for the period February 1, 1959, to September 30, 1959, as well as the operations of Stauffer New Mexico for the period from October 1, 1959, to January 31, 1960.
For many years prior to 1954, Bernard H. Stauffer was the owner of a patent covering a mechanical oscillating unit designed to provide passive and resistive exercise for use in a program of weight and posture control. The business of exploiting the patented device was conducted for many years by Stauffer Laboratories, a California partnership composed of Bernard H. Stauffer and his sister, Sally Stauffer. For several years prior to 1954 *100 the business had been carried on through franchised salons, where customers were counseled with respect to a weight control program and allowed to use one of the exercise units. In 1954, a "Stauffer Home Plan" was inaugurated for the retail sale of units embodying the patented device. Eventually, sales of these units by the Stauffer enterprise (as carried on by corporations hereinafter described) were handled by 23 regional distributors who operated in franchise territories; they in turn sold the products to the ultimate consumers through local distributors or branch offices which employed a staff of 3,500 "counselors."
In 1956 the substantial bulk of the activities previously carried on by the partnership, Stauffer Laboratories, was taken over by the three *280 old Stauffer companies (Stauffer California, Stauffer Illinois, and Stauffer New York). All of the stock of these corporations was owned by the partnership, but in July 1958 Bernard H. Stauffer purchased the partnership interest of his sister, and was at all times thereafter the sole owner of the business, conducted as a sole proprietorship under the name of Stauffer Laboratories, and of the stock of the three corporations. *101 All of his interests in these various business entities were subject to the community property rights of his wife, Bonnie H. Stauffer.
Stauffer California was incorporated under the laws of California in 1956. Its principal activity consisted of the manufacture and sale of mechanical reducing equipment. Until 1958, all units sold by the old Stauffer companies were manufactured by Stauffer California in its facilities in Los Angeles, but after that time Stauffer Illinois also manufactured some of these units. Stauffer California promoted the Stauffer Home Plan in the Western United States, and also granted franchise agreements within its specified territory, leasing certain exercise units to independent contractors who operated reducing salons offering the "Stauffer System," the trade name for this method of weight control. The corporation's principal place of business was 1919 Vineburn Avenue, Los Angeles, Calif.
Stauffer Illinois was incorporated under the laws of Illinois in 1948. 1 At least from about 1956 it promoted the Stauffer Home Plan in the Midwest, and it entered into franchise agreements and leases with independent salons within its specified territory. From 1958 *102 it also engaged in manufacturing some of the reducing equipment in rented facilities in West Memphis, Ark., and Little Rock, Ark. Its principal place of business was in Chicago, Ill.
Stauffer New York was incorporated under the laws of New York in 1956. It conducted no manufacturing operations of its own, but sold the mechanical reducing apparatus manufactured by Stauffer California and Stauffer Illinois. It promoted the Stauffer Home Plan in the Northeastern United States. It also entered into franchise agreements and leases with independent salons within its specified territory. Its principal place of business was in New Jersey.
The officers and directors of each of the three corporations were the following persons:
| Name | Office Held |
| Bernard H. Stauffer | President and director |
| L. R. d'Assalenaux | Executive vice president and |
| director | |
| Bonnie Stauffer | Secretary and director |
| Sally Stauffer | Director |
*281 There was a fifth director of Stauffer New York, H. W. Parke, an employee of C-T Corp., who was designated as a director only to satisfy the requirements *103 of New York law that there be at least one resident director of every New York corporation. Parke never attended or participated in a meeting of the directors of Stauffer New York.
Meetings of the boards of directors of the three Stauffer companies were always held at the offices of Stauffer California. No meetings of directors or shareholders were held in either Illinois or New York.
Accounting records for each of the three corporations were prepared and kept by means of IBM machines located in the Los Angeles office of Stauffer California.
During the latter part of 1958, Bernard H. Stauffer was approached by representatives of Deming and of Albuquerque, N. Mex., and solicited to relocate the Stauffer operations in those cities. It was ultimately determined to relocate in Albuquerque. Pursuant to this decision Stauffer California acquired an option to purchase an industrial plant site near that city.
In connection with the proposed relocation of the Stauffer enterprise in New Mexico, Bernard H. Stauffer caused the formation of Stauffer New Mexico in August 1959. Its officers and directors were the same as those of the three old Stauffer companies, and Bernard H. Stauffer was similarly *104 the sole stockholder. A plan of reorganization was formulated whereby the three old Stauffer companies would merge into Stauffer New Mexico on October 1, 1959. In proposing the plan to the board of directors of Stauffer California on August 14, 1959, Bernard H. Stauffer stated that the merger was deemed advisable "in view of the possibility of effecting substantial reductions in manufacturing and overhead costs through the combination of all of the facilities and operations in one central location, to the greatest extent possible, and the coordination of supervisorial activities. Further, it would be possible through the merger to bring all of the activities of the business within a single corporate body subject to the jurisdiction of the State of New Mexico, in which State most of the assets of the business would be located." Pursuant to the plan, a formal merger agreement was approved by Bernard H. Stauffer in his capacity as sole stockholder of each of the four corporations and was executed by him and his wife on September 28, 1959, in their capacities as president and secretary, respectively, of each of the four corporations.
The merger agreement was in fact carried out on October *105 1, 1959, pursuant to its terms which, in part, provided in substance (1) that each of the three old Stauffer companies would merge with Stauffer New Mexico in accordance with the laws relating to statutory mergers of domestic and foreign corporations in each of the four States *282 and that thereafter Stauffer New Mexico would be the surviving corporation; (2) that the stated capital, paid-in surplus and retained earnings of Stauffer New Mexico would be an amount equal to the sum of such items of the three constituent corporations; (3) that all property of any kind of the three constituent corporations would be vested in Stauffer New Mexico which would be responsible for all liabilities and obligations of the three constituent corporations; and (4) that on the effective date of the merger the separate existence of each of the three constituent corporations would cease.
In connection with the consummation of the merger the agreement provided that it would not become effective or binding upon any of the constituent corporations, their officers, or stockholders until a copy of the agreement and any other certificates or documents required by law were properly filed and recorded with the proper *106 governmental agencies in each of the four States involved.
The merger agreement was in fact filed in the office of the secretary of state of the State of New Mexico early in the morning of October 1, 1959. Counsel for the companies was advised thereof on that morning, and promptly called the secretary of state of the State of California to request that the merger agreement, which had been mailed to that office on September 30, 1959, be filed with the secretary of state of the State of California. The merger agreement was so filed in California on October 1, 1959. The merger agreement was filed with the secretary of state of the State of Illinois as of 5 p.m. on October 1. The merger agreement was filed with the Department of State of the State of New York at approximately 4:30 p.m. on October 1. Upon completion of the merger, on October 1, 1959, after issuance of additional stock of Stauffer New Mexico in respect of the stock of each of the three constituent corporations, Bernard H. Stauffer remained the sole stockholder of Stauffer New Mexico.
On or about August 13, 1959, a request for a ruling as to the tax consequences of the proposed reorganization had been submitted to the *107 Internal Revenue Service. The merger, as planned, was outlined, and the Service was asked to rule, inter alia, that it would constitute a "reorganization" within the meaning of section 368(a) (1) (A) ("a statutory merger or consolidation"). There was no request for any ruling as to whether the proposed merger would also qualify as a reorganization within the meaning of section 368(a) (1) (F). On September 14, 1959, the Service ruled that the proposed merger would be a section 368(a) (1) (A) reorganization and ruled favorably on all other requests, such as those dealing with nonrecognition of gain or loss and carryover of basis of assets.
The option to acquire the real property in the Albuquerque area which had been obtained by Bernard H. Stauffer on behalf of Stauffer *283 California, was exercised and the proposed industrial site acquired by Stauffer California on or about September 29, 1959, at a price of $ 130,500. Title was taken in the name of Stauffer New Mexico by deed recorded on October 1, 1959. However, because of reversals in business fortunes hereinafter more fully described, the contemplated relocation to New Mexico was never carried out. Instead, Stauffer New Mexico's *108 principal place of business was 1919 Vineburn Avenue, Los Angeles, Calif., which had previously served as the main office of Stauffer California and from which the affairs of all the Stauffer enterprises had been guided and controlled. It continued to carry on the operations previously conducted by the old Stauffer companies from the same locations and in the same manner as before the merger. The accounting records continued to be broken down as though the three old Stauffer companies were still in existence, except that no intercompany profits appeared on the books.
Stauffer New Mexico was liquidated on January 31, 1961, and its assets, subject to its liabilities, were distributed to Bernard H. Stauffer, who thereafter continued the same business operations as a sole proprietor.
The old Stauffer companies, each of which had previously filed separate corporate returns and had reported income on a fiscal year basis (February 1 to January 31), did not file closing tax returns for the period from February 1, 1959, the beginning of the new fiscal year, to September 30, 1959, the last day of their separate existence. It was originally intended that the old Stauffer companies would file *109 such closing returns, however, and on December 15, 1959, a request was filed on behalf of each of them for an extension of time for filing returns for the period February 1, 1959 to September 30, 1959. The following sums were paid along with these requests:
| Stauffer California | $ 300,000 |
| Stauffer Illinois | 200,000 |
| Stauffer New York | 7,500 |
Instead of filing closing returns for the old Stauffer companies, however, a return was filed in the name of Stauffer New Mexico which included both the operations of the old Stauffer companies for the period February 1, 1959-September 30, 1959, and the operations of Stauffer New Mexico for the period from October 1, 1959, to January 31, 1960. Attached to the return was a statement describing the merger of the old Stauffer companies into Stauffer New Mexico, which contained the following paragraph:
Taxpayer has been advised by counsel that inasmuch as the reincorporation of California, Illinois, and New York in the State of New Mexico involved no change in the existing stockholders or change in the assets of the corporations *284 involved, but was intended to effectuate relocation of the corporate domiciles in the State of New Mexico, the reorganization is within *110 the scope of section 368(a) (1) (F) and section 381(b); and that under the authority of Rev. Rul. 57-276 (1 C.B. 126">1957-1 C.B. 126), a single return must therefore be filed by Stauffer Laboratories, Inc. [Stauffer New Mexico], for the fiscal year commencing February 1, 1959 and ending January 31, 1960, claiming only a single surtax exemption, and combining the operations of all of the corporations for the entire fiscal year, and that separate closing returns for New York, Illinois, and California should not be filed.
The schedule below shows the total sales income, the cost of sales (based on inventory figures at cost rather than on alleged revised market values now contended for by petitioner), gross profit, other income, total expenses, taxable income, and the tax which would be due thereon for (1) each of the three old Stauffer companies for the period February 1, 1959, to September 30, 1959, (2) for Stauffer New Mexico for the period October 1, 1959, to January 31, 1960, and (3) for the combined operations of all four corporations for the full 12-month fiscal year ended January 31, 1960:
| Feb. 1, 1959-Sept. 30, 1959 | ||||
| Item | ||||
| California | Illinois | New York | Total | |
| Sales | $ 10,357,866 | $ 4,643,536 | $ 1,132,368 | $ 16,133,770 |
| Cost of sales | 6,316,967 | 3,719,456 | 561,450 | 10,597,873 |
| Gross | 4,040,899 | 924,080 | 570,918 | 5,535,897 |
| Other income | 147,402 | 38,266 | 30,256 | 215,924 |
| Total income | 4,188,301 | 962,346 | 601,174 | 5,751,821 |
| Expenses | 3,385,377 | 296,340 | 578,027 | 4,259,744 |
| Taxable | 802,924 | 666,006 | 23,147 | 1,492,077 |
| Tax | 412,021 | 340,822 | 6,943 | 759,787 |
| Oct. 1, | FYE Jan. | |
| 1959-Jan. | 31, 1960 | |
| 31, 1960 | ||
| Item | ||
| New | Total per | |
| Mexico | return | |
| Sales | $ 1,546,410 | $ 17,680,180 |
| Cost of sales | 933,391 | 11,531,264 |
| Gross | 613,019 | 6,148,916 |
| Other income | 10,671 | 226,595 |
| Total income | 623,690 | 6,375,511 |
| Expenses | 1,419,227 | 5,678,971 |
| Taxable | (795,537) | 696,540 |
| Tax | (403,086) | 356,701 |
*111 The figures appearing in the last column of the foregoing schedule are identical with those reported by Stauffer New Mexico in its return for the full year ended January 31, 1960, in respect of the operations of all four corporations. Thus, that return showed an income tax due in the amount of $ 356,701. The sums totaling $ 507,500 paid on behalf of Stauffer California, Stauffer Illinois, and Stauffer New York with their earlier requests for extensions of time to file closing returns were claimed by Stauffer New Mexico as taxes paid, and it claimed a refund of $ 150,799.
During the summer and fall of 1960, Internal Revenue Service agents conducted an examination of the Federal income tax returns of the old Stauffer companies for the years ended January 31, 1958 and *285 1959, and of Stauffer New Mexico for the period ended January 31, 1960. A report was prepared on this examination under date of January 27, 1961. The Service did not contest the filing of a single return by Stauffer New Mexico for the year ended January 31, 1960, in the manner described above. Comparatively small deficiencies were assessed against each of the old Stauffer companies for the years ended January 31, 1958 *112 and 1959, and an overassessment was determined as to Stauffer New Mexico for the year ended January 31, 1960. The following schedule details the amounts of taxable income and tax due reported by the three old Stauffer companies for the fiscal years ended January 31, 1958 and 1959, as well as the audit adjustments made by the Internal Revenue Service to the returns and the additional tax due and paid as a result of said adjustments:
| Stauffer | Stauffer | Stauffer | |
| California | Illinois | New York | |
| FYE Jan. 31, 1958 | |||
| Income originally reported | $ 2,849,926 | $ 1,652,267 | $ 197,864 |
| Audit adjustments | 9,984 | 5,905 | 5,808 |
| Income as last adjusted | 2,859,910 | 1,658,172 | 203,672 |
| Tax originally paid | 1,476,462 | 853,679 | 97,389 |
| Additional tax, per audit | 5,191 | 3,070 | 3,020 |
| Tax paid | 1,481,653 | 856,749 | 100,409 |
| FYE Jan. 31, 1959 | |||
| Income originally reported | 4,075,701 | 406,685 | 66,977 |
| Audit adjustments | 22,780 | 12,808 | 6,687 |
| Income as last adjusted | 4,098,481 | 419,493 | 73,664 |
| Tax originally paid | 2,111,655 | 205,976 | 29,328 |
| Additional tax, per audit | 11,845 | 6,660 | 3,477 |
| Tax paid | 2,123,500 | 212,636 | 32,805 |
In its closing Federal income tax return for the fiscal year ended January 31, 1961, Stauffer New Mexico reported a net operating loss of $ 3,366,052. The Stauffer corporations have at all times *113 consistently employed the lower of cost or market method of determining inventory values, and in computing the income of Stauffer New Mexico in that return, its closing inventories were written down from book value to an alleged market value that was less than book value. The opening inventories were valued at book.
The following table, prepared from the books of Stauffer New Mexico, represents a breakdown of the income and expenses of Stauffer New Mexico for the year ended January 31, 1961, to show the loss attributable to each of the businesses previously conducted by the old Stauffer companies: *286
| New York | Illinois | California | Total | |
| Sales | $ 173,412 | $ 111,202 | $ 617,332 | $ 901,946 |
| Cost of goods sold | ||||
| inventory -- Feb. 1, 1960 | 137,367 | 711,231 | 1,413,503 | 2,262,101 |
| Cost input | 343,521 | 361,596 | 705,117 | |
| Less inventory -- Jan. 31, 1961 | (7,428) | (398,490) | (60,270) | (466,188) |
| Cost of goods sold | 129,939 | 656,262 | 1,714,829 | 2,501,030 |
| Gross profit (loss) | 43,473 | (545,060) | (1,097,497) | (1,599,084) |
| Expenses | 170,248 | 509,528 | 1,087,192 | 1,766,968 |
| Loss for the year | (126,775) | (1,054,588) | (2,184,689) | (3,366,052) |
The loss figures for each of the old Stauffer companies are not strictly comparable with the premerger taxable income reported *114 on the separate returns filed by the three corporations, because intercompany profits, which constituted part of the cost of finished goods inventory in the premerger returns, did not appear in the post-merger books and were not reflected in inventory in this breakdown. However, home office expenses and executive salaries were allocated among the three businesses in the same manner both before and after the merger.
The operating loss shown on the return of Stauffer New Mexico for the year ended January 31, 1961, was reflected on an Application for Tentative Carryback Adjustment filed by Stauffer New Mexico on or about April 10, 1961. In its application, Stauffer New Mexico requested a refund of (a) $ 1,481,653, consisting of all taxes theretofore paid by Stauffer California on its income for the year ended January 31, 1958, and (b) $ 263,194 of the income taxes paid by Stauffer California with respect to the year ended January 31, 1959. On the application Stauffer New Mexico stated that it was "a continuing corporation pursuant to a reorganization under IRC Section 368(a)(1)(F)," but it did not identify Stauffer California or any other named corporation as the predecessor in the *115 reorganization.
This application for a so-called "quickie" refund was based on section 6411 of the Internal Revenue Code of 1954 which, so far as is relevant here, authorizes the Secretary or his delegate to make a refund to a taxpayer within 90 days of his application therefore based upon the tentative allowance of a net operating loss carryback. This allowance is to be made on the basis of a limited examination of facts and figures submitted by the taxpayer to determine whether omissions or errors of computation have been made. No omissions or errors in computations having been found, Stauffer New Mexico's tentative carryback claim was allowed. The amounts so allowed, $ 1,481,653 tax and $ 12,035.89 interest for fiscal 1958 and $ 263,194 tax and $ 2,138 interest for fiscal 1959, were paid by checks drawn to Stauffer New Mexico, and negotiated on April 18, 1961, by Bernard H. Stauffer as trustee in dissolution and former sole stockholder of the then-dissolved corporation.
*287 The book values of the assets transferred from each of the old Stauffer companies to Stauffer New Mexico on October 1, 1959 (exclusive of liability for Federal income taxes, if any), together with adjustments for *116 a disputed inventory write-down claimed by petitioner, were as follows:
| Disputed | Book, net of | ||
| Book value | inventory | disputed | |
| write-down | write-down | ||
| Stauffer California | $ 4,510,158 | $ 842,883 | $ 3,667,285 |
| Stauffer Illinois | 1,828,285 | 450,889 | 1,377,396 |
| Stauffer New York | 183,970 | 17,290 | 166,680 |
| Total | 6,522,423 | 1,311,062 | 5,211,361 |
The fair market value of these assets was at least equal to the book value, net of the inventory write-down, if any.
At January 31, 1961, the net book value of the assets of Stauffer New Mexico transferred in liquidation to Bernard H. Stauffer was $ 3,778,303. The fair market value of those assets equaled or exceeded their net book value.
On or about November 30, 1961, Bernard H. Stauffer, acting in his capacity as trustee in dissolution, former president, and former sole stockholder of Stauffer New Mexico, executed a document entitled "Transferee Agreement -- Corporation" (Form 2045) on behalf of Stauffer New Mexico. In this document Stauffer California was denominated as "Transferor" and Stauffer New Mexico as "Transferee." The document provided in part as follows:
In consideration of the Commissioner of Internal Revenue not issuing a statutory notice of deficiency to and making an assessment *117 against the above-named transferor corporation, the undersigned admits that it is the transferee of assets received from said transferor corporation, and assumes and agrees to pay the amount of any and all Federal income, excess-profits, or profits taxes finally determined or adjudged as due and payable by the above-named transferor corporation for the taxable year (or years) ended 1/31/58 and 1/31/59, to the extent of its liability at law or in equity, as a transferee within the meaning of Section 6901 of the Internal Revenue Code of 1954 and corresponding provisions of prior internal revenue laws;
Stauffer Laboratories, Inc.
(dissolved January 31, 1961)
By B. H. Stauffer,
Transferee (former Pres. & sole stockholder)
Facts Relating to Claimed Write-down of Inventory as of September 30, 1959. 2 -- For many years the Stauffer organization (i.e., the *288 various Stauffer entities considered in the aggregate) was recognized as a leader in the weight control industry. Prior to April of 1958, the only unit manufactured and sold with the Stauffer Home Plan was the model S or S-1 (S being the earlier version of S-1). This unit had a manufacturing cost of approximately $ 60, wholesaled at $ 144.75, *118 and retailed at $ 299.50.
During 1958 a large number of competitors entered the reducing-aid field, offering promises of weight reduction through various means, at prices ranging upwards from a few dollars for various pills and dietary supplements. Mechanical and electrical devices were offered to the public at prices ranging as low as $ 8.88 per unit. Devices comparable in appearance to the products of the Stauffer companies were offered at a wide range of prices. Department stores offered units identified as having retail prices of $ 199 at "special" prices of $ 99.50 or even $ 79.95.
From April 1958 until September 1959, the Stauffer companies, in an effort to combat competition, introduced a variety of models in different price ranges. Each of these models involved the same oscillating unit principle, to which were added various attachments. The models being sold during this period were the following:
| Model identification | Manufacturing | Wholesale | Retail price |
| cost | price | ||
| S-1 | $ 60 | $ 144.75 | $ 299.50 |
| L | 45 | 99.75 | 199.50 |
| C | 124 | 169.50 | 399.00 |
| H | 50 | 89.50 | 179.00 |
| W | 192 | 245.25 | 545.00 |
The *119 S-1 remained the most important model, but a substantial number of units of model L were also sold. The other models (except for H which first appeared at about the end of this period and which displaced L in relative importance in November 1959) were of distinctly lesser importance and accounted for a comparatively small number of sales.
The greatly increased publicity resulting from the advertising done by the Stauffer companies and their competitors during 1958 and 1959 attracted the attention of the U.S. Department of Health, Education, and Welfare to mechanical reducing devices. On September 2, 1959, Arthur S. Fleming, then the Secretary of Health, Education, and Welfare, held a news conference at which he attacked the manufacturers of such devices on the ground that they were wholly ineffective to accomplish the results claimed. A news release to this general effect was issued at this conference, and was widely reported in the daily papers on the following day.
*289 Other unfavorable publicity followed. In its September 1959 issue, Consumer Research published a report on mechanical reducing equipment which concluded that expenditures for such equipment could only be justified as *120 an entertainment item for being "jiggled, jarred or electrified." In its December 1959 issue, Readers Digest published an article entitled "They Take Your Money -- You Keep Your Weight" which also treated weight reducing equipment in a disparaging manner. The sweeping derogatory comments on weight-reducing devices in these articles did not distinguish the mechanical devices producing vibration and massage (such as those commonly employed by Stauffer's competitors) from the Stauffer products embodying the oscillating principle. Finally, in March 1960, the Federal Trade Commission began proceedings to force Stauffer to cease and desist from the use of certain advertising regarding its products.
Average Stauffer sales for the year 1959 were in excess of 7,000 units per month, and in September of 1959, notwithstanding the adverse publicity, 8,259 units were sold, substantially in excess of the 5,797 units sold during the preceding month of August 1959 and in excess of the 6,700 units sold during the corresponding month of September 1958. However, sales declined to 5,288 units in October, to 2,960 units in November, and to 557 units in December. By 1960 the unfavorable publicity had *121 taken its toll to the point where sales averaged only about 350 units a month for the entire year. The combined unit sales of all the Stauffer companies from January 1958 through December 1961 (including the period from February 1, 1961, through December 31, 1961, in which the business was run by Bernard H. Stauffer as a sole proprietorship) were as follows:
| Month | 1958 | 1959 | 1960 | 1961 |
| January | 9,965 | 7,102 | 293 | 106 |
| February | 7,930 | 12,854 | 543 | 135 |
| March | 8,682 | 14,463 | 610 | 147 |
| April | 11,615 | 11,107 | 524 | 122 |
| May | 12,088 | 8,528 | 222 | 139 |
| June | 9,567 | 7,072 | 387 | 167 |
| July | 8,847 | 6,618 | 258 | 148 |
| August | 14,031 | 5,797 | 422 | 128 |
| September | 6,700 | 8,259 | 375 | 148 |
| October | 8,072 | 5,288 | 408 | 101 |
| November | 7,479 | 2,960 | 139 | 93 |
| December | 7,627 | 557 | 149 | 92 |
| Total | 112,603 | 90,605 | 4,330 | 1,526 |
During the period from August 1959 through January 1961, the following wholesale and suggested retail prices were generally in effect: *290
| Unit price | |||
| Model | Period (inclusive) | Wholesale | Suggested |
| retail | |||
| S-1 | August 1959-January 1960 | $ 144.75 | $ 299.50 |
| January 1960-May 1960 | 124.00 | 289.50 | |
| June 1960-January 1961 | 144.75 | 289.50 | |
| L | August 1959-October 1959 | 80.00 | 149.50 |
| November 1959-November 1960 | 99.75 | 199.50 | |
| December 1960-January 1961 | 60.00 | 199.50 | |
| W | September 1959-February 24, 1960 | 245.25 | 545.00 |
| March 1960-January 1961 | 218.00 | 545.00 | |
| C | Month of August 1959 | 169.50 | 339.00 |
| September 1959-August 1960 | 149.70 | 339.00 | |
| September 1960-October 1960 | 129.50 | 339.00 | |
| November 1960-January 1961 | 39.50 | 339.00 | |
| H | October 1959-January 1960 | 89.50 | 179.00 |
| February 1960-January 1961 | 63.95 | 139.50 |
On *122 or about September 30, 1959, the accounting firm of Price, Waterhouse & Co. commenced an audit of the Stauffer companies for the period from February 1, 1959, to September 30, 1959, for the purpose of preparing certified financial statements for each of the companies. Representatives of the firm observed the inventories on or about September 30, 1959, and then returned in mid-October to begin actual work on the audit. During the course of the examination, the senior accountant in charge of the field work on the audit, Mr. Rubin Weprin, became concerned about the inventories. In his opinion there was an "imbalance" in various categories (i.e., a situation in which some parts needed to complete certain units were in oversupply as against others that were in undersupply). He was disturbed by the "bad shape" in which he found the companies' inventory records, and he had doubts about the salability of one of the new models, model C (a cradle embodying the oscillating device), which he did not regard as a "good product." He did not appear to have any doubts about any of the other models. And although he had additional concern based upon the downward trend in selling activities which *123 he observed during October and November of 1959, the record does not disclose that such concern was based in any part upon the level or trend of selling activities on or prior to September 30, 1959. Working balance sheets were prepared from the books of the companies, but Price, Waterhouse was not willing to certify the balance sheets, and it never certified any financial statements for the old Stauffer companies for this period.
On January 31, 1960, and for sometime prior to that date, Bernard H. Stauffer was a party to a loan agreement with the Bank of America under which he had pledged all the capital stock of Stauffer New Mexico as security for a substantial personal loan. In the agreement, he promised to maintain the net worth and working capital of the corporation in excess of certain amounts, and to furnish the bank periodically with financial statements prepared in accordance with generally accepted accounting principles.
*291 On February 12, 1960, the controller of Stauffer New Mexico submitted financial statements of Stauffer New Mexico as of January 31, 1960, to the Bank of America, on which the value of Stauffer New Mexico's closing inventories, computed at the lower of cost *124 or market, was shown as $ 2,333,751. On or about March 15, 1960, Stauffer New Mexico filed its income tax return for the fiscal year ended January 31, 1960, in which the same inventories were valued at $ 2,262,101. The financial statements furnished to the Bank of America and tax return of Stauffer New Mexico, though showing different values for the closing inventory on January 31, 1960, reflected inventories at book value, computed at cost, and not market value. No inventory write-down from book value was claimed by Stauffer New Mexico on its Federal income tax return for its fiscal year ended January 31, 1960.
Price, Waterhouse & Co. returned for a preliminary examination of the financial statements of Stauffer New Mexico for its fiscal year ended January 31, 1960 (which included the separate operations of the three old Stauffer companies for the first 8 months of the fiscal year), in March 1960. Rubin Weprin, again in charge of the field work, felt that the inventories on hand at January 31, 1960, were overstated on the books and the financial statements of Stauffer New Mexico. Uncertainty as to the ability of Stauffer New Mexico to realize the cost of its inventories was one *125 of the reasons why Price, Waterhouse did not certify the financial statements of the company for the year ended January 31, 1960.
On August 3, 1960, accountants from Price, Waterhouse revisited Stauffer New Mexico and reviewed its financial statements for the 4 months ended May 31, 1960, to see if it was possible to assign a precise valuation to the January 31, 1960, inventory. The review disclosed that operations had not significantly changed since completion of the field work in connection with the January 31, 1960, statements, and that Bernard H. Stauffer was still highly optimistic about the business resuming profitable operations in the near future. In view of the conflict between the Price, Waterhouse auditors and Bernard H. Stauffer as to the ability of Stauffer New Mexico to sell its inventory in the future, Price, Waterhouse refused to certify the value of the inventory as of January 31, 1960.
It was not until the fall of 1960 that the management of Stauffer New Mexico became convinced that a significant cutback in operations would be necessary to avoid further losses, and that an extended period of time would be required to rebuild public confidence in Stauffer products. *126 It was determined at that time that Stauffer New Mexico should be liquidated, with Bernard H. Stauffer continuing the business, in a diminished form, as a sole proprietorship. It was hoped that the remaining completed S-1 units could be sold, and that the partially *292 completed S-1 units would be completed and sold. All other models would be discontinued and the parts inventory for those models disposed of.
Stauffer New Mexico was in fact liquidated on January 31, 1961. In its closing tax return for the fiscal year ended January 31, 1961, the book values of its inventories on hand at the close of the fiscal year were written down. All parts on hand were valued at their scrap value, and all finished units, except the model S-1, were treated as worthless. The S-1's were valued at $ 30, which was approximately 50 percent of their book value at cost.
The following schedule shows the total finished units of models L, C, H, and W on hand as of October 1, 1959; the number of additional units manufactured between October 1, 1959, and January 31, 1960; the total of such units available for sale; the total sales of such units between October 1, 1959, and January 31, 1961, and the total of *127 such units unsold on January 31, 1961:
| Model | ||||
| L | C | H | W | |
| Finished units, Oct. 1, 1959 | 4,728 | 541 | 0 | 95 |
| Additional units manufactured by Jan. 31, 1960 | 1,639 | 954 | 1 4,174 | 563 |
| Total units available for sale, Oct. 1, 1959 to | ||||
| Jan. 31, 1960 | 6,367 | 1,495 | 1 4,174 | 658 |
| Total units sold from Oct. 1, 1959 to Jan. 31, 1961 | 3,197 | 127 | 2,185 | 156 |
| Units unsold, Jan. 31, 1961 | 3,170 | 1,368 | 1,989 | 502 |
In determining deficiencies in the income taxes of Stauffer California, Stauffer Illinois, and Stauffer New York resulting from their failure to file closing tax returns for the period February 1, 1959, to September 30, 1959, it was necessary for the Commissioner to determine the taxable income of the three corporations for this 8-month period. In arriving at figures for taxable income and, more particularly, in computing the cost of goods sold deduction for each corporation, the Commissioner used the book values of the inventories, at cost, as the valuation of the closing inventories on September 30, 1959.
The Stauffer companies have at all times consistently employed the lower of cost or market method of determining inventory values, and the cost (or book value) *128 of the inventory of each of the Stauffer companies at September 30, 1959, thus used by the Commissioner was as follows:
| Stauffer California | $ 1,185,757 |
| Stauffer Illinois | 757,585 |
| Stauffer New York | 324,428 |
| 2,267,770 |
*293 During the early part of 1963, in connection with the processing of these proposed deficiencies, Price, Waterhouse & Co. was requested by petitioner to furnish a value of the closing inventory of the old Stauffer companies on September 30, 1959, using the lower of cost or market method of inventory valuation. At this time, Price, Waterhouse concluded that the market value of the closing inventories on September 30, 1959, was lower than its book value, at cost, in the amount of $ 1,311,062. The following schedule, prepared by Price, Waterhouse & Co., shows in summary form how Price, Waterhouse arrived at this write-down:
| STAUFFER LABORATORIES, INC. | |||
| Summary of Inventory Write-down as at September 30, 1959 | |||
| Models W, C, | |||
| Model S-1 | H and L and | ||
| parts | and other | Total | |
| parts | |||
| Parts inventory: | |||
| Inventory Sept. 30, 1959 | $ 528,800 | $ 786,548 | $ 1,315,348 |
| Add purchase commitments | 334,906 | 105,760 | 440,666 |
| Total available for use | 863,706 | 892,308 | 1,756,014 |
| Less -- Cost of Sept. 30, 1959 | |||
| material used in production during | |||
| the period Oct. 1, 1959 to Jan. 31, | |||
| 1960 | (213,665) | (297,402) | (511,067) |
| Less -- Labor and burden included in | |||
| Sept. 30, 1959 inventory | (54,613) | (76,041) | (130,654) |
| Sept. 30, 1959 inventory still on hand | |||
| at Jan. 31, 1960 (material costs | |||
| only) | 595,428 | 518,865 | 1,114,293 |
| Cost of material used in production | |||
| from Feb. 1, 1960 to Jan. 31, 1961 | (80,834) | (34,933) | (115,767) |
| Sept. 30, 1959 inventory still on hand | |||
| at Jan. 31, 1961 | 514,594 | 483,932 | 998,526 |
| Proceeds from scrap sales Oct. 1, 1959 | |||
| to Jan. 31, 1961 | 62,668 | ||
| Unrecovered cost of Sept. 30, 1959 | |||
| inventory as at Jan. 31, 1961 | 935,858 | ||
| Finished goods inventory: | |||
| Losses on finished units -- | |||
| Model L | 140,306 | ||
| Model C | 123,050 | ||
| Model H | 57,931 | ||
| Model W | 53,917 | ||
| 1,311,062 |
*129 *294 In its determination that the market value of the closing inventories on September 30, 1959, was $ 1,311,062 less than the cost figures used by the Commissioner, Price, Waterhouse used as its "market" figures the alleged "net realizable value" of the inventories rather than the reproductive or replacement values of the inventories.
The cost values of the closing inventories of the old Stauffer companies as of September 30, 1959, used by the Commissioner, together with the proposed write-down of those inventories made by Price, Waterhouse in 1963, are as follows:
| Book value | Write-down | Reduced value | |
| Stauffer California | $ 1,185,757 | $ 842,883 | $ 342,874 |
| Stauffer Illinois | 757,585 | 450,889 | 306,696 |
| Stauffer New York | 324,428 | 17,290 | 307,138 |
| Total | 2,267,770 | 1,311,062 | 956,708 |
Petitioner contends that the inventory of each of the three companies as thus reduced represents its net realizable value at September 30, 1959.
The net realizable value of each of these inventories at September 30, 1959, was not less than its respective cost or book value.
OPINION
1. (F) Reorganization Issue. -- Each of the three old Stauffer companies (California, Illinois, and New York), the taxpayers herein, had a fiscal year ending January *130 31. On October 1, 1959, all three were absorbed by Stauffer New Mexico pursuant to the statutory merger laws of California, Illinois, New York, and New Mexico, and their separate existence ceased on that day. The two principal questions before us are (a) whether the taxable year of each of the old companies was required to end at the time of the merger, with the consequence that each was obliged to file a closing return for the period February 1-September 30, 1959, and (b) whether a net operating loss sustained by the new company for its fiscal year ending January 31, 1961, could be carried back and applied against the income of Stauffer California for its fiscal years ending January 31, 1958 and 1959. 3
The mere fact that there has been a tax-free reorganization is not sufficient to relieve the old companies of their obligation to file closing returns, nor does it authorize the carryback in question. Indeed, section *295 381(b) (1) and (3) 4*132 make it abundantly clear that unless the reorganization is one that qualifies under subparagraph (F) of section 368(a)(1), 5*133 the two principal issues must be decided against the petitioner. *131 So much is not in dispute, and the matter turns entirely upon whether there was an (F) reorganization.
An (F) reorganization is one of six types of transaction (subparagraphs (A) through (F)) that are included within the meaning of the term "reorganization" as it is defined in section 368(a)(1) -- all of which may result in tax-free transfers or *134 exchanges. However, an (F) reorganization is strictly limited to "a mere change in identity, form, or place of organization, however effected."
*296 Before consummating the reorganization in question the parties had sought and obtained from the Internal Revenue Service a ruling to the effect that the transaction would result in a tax-free reorganization as a "statutory merger or consolidation" within the meaning of subparagraph (A) of section 368(a)(1). It was then expected that each of the constituent companies would file closing returns, and indeed, as late as December 15, 1959, an application was filed on behalf of each of the three old Stauffer companies for an extension of time for filing returns for the period February 1-September 30, 1959. Accompanying that request was a payment of $ 300,000 on behalf of Stauffer California, $ 200,000 on behalf of Stauffer Illinois, and $ 7,000 on behalf of Stauffer New York. It was only later, when it became clearly apparent that the new company had sustained substantial losses during the 4-month period, October 1, 1959-January 31, 1960, that it was determined to file a single return for the full fiscal year February 1, 1959-January 31, 1960, *135 in the name of the new company and to include therein the profitable operations of the three old Stauffer companies for the first 8 months against which the losses of the last 4 months were applied. In order to justify that course of action, as well as the failure to file closing returns for the three old Stauffer companies, the position was taken that the merger of the three old companies into Stauffer New Mexico was an (F) reorganization. Of course, if the merger was an (F) reorganization then the course of action taken would have been proper under section 381(b)(1). Similarly, the existence of an (F) reorganization would have removed the prohibition against the carryback of the fiscal 1961 net operating loss to a pre-merger year pursuant to section 381(b)(3). We hold that the merger was not an (F) reorganization.
It must be remembered at the outset that all reorganizations, (A) through (F), may result in tax-free exchanges, and that the reason for nonrecognition upon such transfers or exchanges is that the taxpayer's interest upon a corporate distribution or exchange of securities may represent "merely a new form of the previous participation in an enterprise, involving no change *136 of substance in the rights and relations of the interested parties one to another or to the corporate assets." Bazley v. Commissioner, 331 U.S. 737">331 U.S. 737, 740. In the aggregate, subparagraphs (A) through (F) represent an attempt to set forth comprehensively the various types of transactions that may be regarded as reorganizations and thus qualify for specified tax-free treatment. But the problems generated by reorganizations went far beyond nonrecognition of gain or loss. Since the reorganized corporation was regarded at least to a certain extent as the successor to an enterprise or enterprises previously carried on in different form, it became necessary to provide for continuity of certain aspects of these businesses *297 from a tax point of view. Thus, section 381 spells out in great detail the extent to which the acquiring corporation in certain reorganizations and other related transactions shall succeed to and take into account various specified items of the distributor or transferor corporation. The general rule for such continuity is contained in section 381(a), footnote 4, supra, and a long list of items to which that general rule applies is set forth in section 381(c). That list *137 deals with such items as net operating loss carryovers, earnings and profits, methods of accounting, inventories, methods of computing depreciation allowance, and a variety of other matters, all cataloged in 22 numbered paragraphs each of which is subject to conditions or limitations set forth therein.
However, Congress was unwilling to provide for complete continuity in every reorganization, and section 381(b), which is captioned "Operating Rules," sets forth certain limitations which in general preclude the continuity of certain items. Thus, except in the case of an (F) reorganization, section 381(b)(1) requires that the taxable year of the transferor corporation shall end on the date of transfer, and section 381(b)(3) explicitly deprives the acquiring corporation of the right to carry back a net operating loss for a taxable year after the transfer to a taxable year of the transferor corporation. This is spelled out in somewhat greater detail in section 1.381(b)-1(a) of the Treasury Regulations which provides:
Sec. 1.381(b)-1 Operating rules applicable to carryovers in certain corporate acquisitions.
(a) Closing of taxable year -- (1) In General. Except in the case of a reorganization *138 qualifying under section 368(a)(1)(F), the taxable year of the distributor or transferor corporation shall end with the close of the date of distribution or transfer.
(2) Reorganizations under section 368(a)(1)(F). In the case of a reorganization qualifying under section 368(a)(1)(F) (whether or not such reorganization also qualifies under any other provision of section 368(a)(1)), the acquiring corporation shall be treated (for purposes of section 381) just as the transferor corporation would have been treated if there had been no reorganization. Thus, the taxable year of the transferor corporation shall not end on the date of transfer merely because of the transfer; a net operating loss of the acquiring corporation for any taxable year ending after the date of transfer shall be carried back in accordance with section 172(b) in computing the taxable income of the transferor corporation for a taxable year ending before the date of transfer; and the tax attributes of the transferor corporation enumerated in section 381(c) shall be taken into account by the acquiring corporation as if there had been no reorganization.
[Italic supplied.]
The underlying theory of these provisions quite *139 plainly is that there is such a complete identity between the pre- and post-reorganization enterprises in an (F) reorganization that the acquiring corporation is *298 to be treated exactly as the transferor corporation would have been treated in the absence of any reorganization. In other words, even though tax-free reorganizations in general are regarded as providing continuity of enterprise and ownership of the business so as to permit the carryover of the various items listed in section 381(c), they nevertheless are not treated as involving sufficient identity in the situations covered by section 381(b), unless the reorganization satisfies the stricter requirements of section 368(a)(1)(F). It is against this background that we must consider the question whether there was an (F) reorganization in this case.
The Government argues that an (F) reorganization is limited to the reorganization of a single corporation and that it does not include the more involved combination of two or more corporations where each has been conducting a separate business. We think that its position is correct, and we reject petitioner's contention that there was an (F) reorganization here because of stockholder *140 identity and the fact that the businesses previously conducted by the three old companies were continued without interruption by the new entity.
The scope of section 368(a)(1)(F) was recently described as follows in Hyman H. Berghash, 43 T.C. 743">43 T.C. 743, 752, affirmed 361 F. 2d 257 (C.A. 2):
Although the exact function and scope of the (F) reorganization in the scheme of tax-deferred transactions described in section 368(a)(1) have never been clearly defined, it is apparent from the language of subparagraph (F) that it is distinguishable from the five preceding types of reorganizations as encompassing only the simplest and least significant of corporate changes. The (F)-type reorganization presumes that the surviving corporation is the same corporation as the predecessor in every respect, except for minor or technical differences. Ahles Realty Corp v. Commissioner, 71 F. 2d 150, affirming an order of this Court. For instance, the (F) reorganization typically has been understood to comprehend only such insignificant modifications as the reincorporation of the same corporate business with the same assets and the same stockholders surviving under a new charter either in the same n3 or in a *141 different State, n4 the renewal of a corporate charter having a limited life, n5 or the conversion of a U.S.-chartered savings and loan association to a State-chartered institution. 6*144 [Footnotes omitted.]
In our judgment the merger of the three viable corporations herein into a single new corporate entity involved changes that were far too significant to be dismissed as a "mere" change in identity, form, or place of organization. True, there was a shift in place of organization to New Mexico. But the reorganization entailed much more. Prior to the merger each of the three old Stauffer companies carried on its own separate business, in its own geographical area. While each had the same officers, it is plain from the manner in which the businesses were conducted that each had its own employees within its own territory. *299 Moreover, only Stauffer California, with its factory in Los Angeles, and Stauffer Illinois in its rented facilities in West Memphis and Little Rock, manufactured Stauffer products. Stauffer New York purchased its needs from the other two and engaged only in selling and leasing activities. There was also an undisclosed amount of buying and selling between Stauffer *142 California and Stauffer Illinois. Moreover, after the merger, a creditor of any of the three could look to the combined assets of the new corporation to satisfy his claim. Important accounting changes also occurred. The respective capital and surplus accounts of the constituent corporations were combined. Yet, if petitioner is correct in the argument that an (F) reorganization is not limited to a single corporation, a deficit in one corporation would offset surplus in another, thus affecting future dividends that might be paid by the new entity under applicable State law. The fact that no such deficit existed here is not important; the point is that this possibility emphasizes the weakness of petitioner's position.
The legislative history of subparagraph (F) throws further light upon the problem. The category of corporate transactions known today as (F) reorganizations has been a part of our tax law since it first appeared in section 202(c)(2) of the Revenue Act of 1921, which defined the term reorganization as including a "mere change in identity, form, or place of organization of a corporation." (Emphasis supplied.) When this definition was reenacted in otherwise identical language *143 in the Revenue Act of 1924, the last three words were dropped. But there was no indication whatever that the deletion was intended to have any significance. To the contrary, the most probable explanation is that the 1924 Act reflected merely a draftsman's preference whereby these words were eliminated as surplusage. Indeed, the House Ways and Means Committee explained the omission of these words and certain other language changes as "minor changes in phraseology." See H. Rept. No. 179, 68th Cong., 1st Sess., p. 13. And in general a type-(F) reorganization has since been regarded as encompassing "only the simplest and least significant of corporate changes" in which one corporation transfers its assets to another which "is the same corporation as its predecessor in every respect, except for minor and technical differences." Hyman H. Berghash, 43 T.C. 743">43 T.C. 743, 752, affirmed 361 F. 2d 257 (C.A. 2) (emphasis supplied). See also Ahles Realty Corp. v. Commissioner, 71 F. 2d 150 (C.A. 2), certiorari denied 293 U.S. 611">293 U.S. 611; George Whittell & Co., 34 B.T.A. 1070">34 B.T.A. 1070. 6
Petitioner has relied upon statements in various cases to the effect that a transaction which shifts the ownership of the proprietary interest *300 in a corporation cannot qualify as a mere change in identity, etc., within the meaning of (F). Cf., e.g., Helvering v. Southwest Consolidated Corp., 315 U.S. 194">315 U.S. 194, 202-203. From such statements petitioner leaps to the conclusion that since there was no shift in proprietary interest here and since the enterprises conducted by each of the three constituent corporations were continued without change by Stauffer New Mexico it necessarily follows that there was an (F) reorganization in this case. The fallacy in such verbal sleight-of-hand is obvious. Certainly, it is necessary that there be continuity of both proprietary interest and enterprise in order to qualify as an (F) reorganization. But that is not enough, for there may be other changes that are too significant to be ignored in determining whether there was a "mere change in identity, form, or place of organization." And in this case substantial changes *145 did occur when the separate businesses of three separate corporations were united in a new corporation.
Only by disregarding the corporate entities of the three old companies can it be said that there was merely that type of purely formal change that characterizes an (F) reorganization. These corporations were separate entities and were treated as such for all purposes, including the computation of taxes. Indeed, there were three separate surtax exemptions, one for each corporation, whereas the new entity admittedly was entitled to only one such exemption. This is not a case of multiple corporations carrying on a single business which may be ignored as a sham. Cf. Aldon Homes, Inc., 33 T.C. 582">33 T.C. 582. There is no question here that these were valid separate corporations, each conducting its own business. And we think that in such circumstances, the unification of these enterprises under a single corporate roof cannot qualify as the kind of mere change in identity, etc., contemplated by section 368(a)(1)(F).
The Supreme Court's opinion in Libson Shops, Inc. v. Koehler, 353 U.S. 382">353 U.S. 382, gives further support to the conclusion that the new corporation cannot be regarded the same, except for *146 minor and technical changes, as its collective predecessors. There, as here, separate corporations owned by the same interests and engaged in related businesses, were merged into one corporation which continued to conduct the entire enterprise in the same manner as before the merger. The Court refused to treat the survivor as the same "taxpayer" as its predecessors, and sustained a disallowance, under the 1939 Code, of a carryover of premerger losses to the post-merger income of the survivor. 7 One of the cases relied upon by the taxpayer was Newmarket Manufacturing Co. *301 v. United States, 233 F.2d 493 (C.A. 1), where a single corporation transferred its business to a corporate shell which the stockholders had set up in another jurisdiction, and a carryover of losses from the predecessor to the post-merger income of the survivor was allowed. The Supreme Court expressly distinguished the Newmarket case, which involved the typical (F) reorganization situation of the reincorporation of a single corporation in another jurisdiction, from the multiple corporation merger before it, on the ground that the multiple reincorporation involves combining several businesses which, up until the time *147 of the merger, had been taxed as separate entities. In the words of the Court, "this difference is not merely a matter of form." 353 U.S. 382">353 U.S. 382, 388. (Emphasis supplied.)
There are indications in the 1954 Code that Congress regarded type (F) as including only the reorganization, by reincorporation or otherwise, of a single corporation, devoid of any other corporate or tax significance. Thus, section 1244 provides in general that losses on common stock of a "small business corporation," so-called "section 1244 stock," may be deducted as ordinary losses instead of losses from the sale or exchange of a capital asset. The applicability of these provisions turns upon a highly complex set of conditions, one of which reads as follows:
Section 1244(d)(2): For purposes of paragraphs (1)(E) and (2)(A) of subsection *148 (c), a successor corporation in a reorganization described in section 368 (a)(1)(F) shall be treated as the same corporation as its predecessor. [Italic supplied.]
The use of the singular words "corporation" and "predecessor" are again evidence that Congress thought of an (F) reorganization in terms of a single corporation. Moreover, if several predecessors can be involved in an (F) reorganization difficult problems would arise as to which predecessor or whether all predecessors taken together may be taken into account in determining whether the complex requirements of subsections (c)(1)(E) and (c)(2)(A) of section 1244 have been satisfied. Unless we follow the obviously intended "one-corporation" reading of the (F) reorganization, we would be faced with a difficult problem for which no solution is provided in the Code or regulations. 8*149
*302 Section 381, which is itself *150 involved herein, also reveals obviously unintended pitfalls and difficulties that would be encountered if the (F) definition were read so as to include the fusion of several brother-sister corporations each conducting an independent enterprise. Paragraph (b)(3) explicitly forbids the carryback of a net operating loss to a taxable year of "the distributor or transferor corporation." In this very case, the new corporation sustained a net operating loss for its fiscal year 1961, and it attempted to carry back that loss to fiscal 1958 and 1959 of only one of its predecessors, Stauffer California. There is no basis whatever in the statute for any such action, nor is there any statutory basis for an allocation as now urged by petitioner. And the plain reason why the problem is not dealt with in these otherwise exceedingly comprehensive provisions is that an (F) reorganization was regarded as involving only one corporation.
The Code is an extraordinarily complex and sensitive instrument, and we should be careful not to give an interpretation to one provision that would generate unintended difficulties in respect of other provisions, unless such interpretation is clearly called for by the *151 statute itself. In the situation before us we can find no such command in the statute requiring the fusion of these three corporations to be treated as a "mere change in identity, form, or place of organization." To the contrary, the indications point the other way.
Petitioner's strongest reliance perhaps is upon our decision in Pridemark, Inc., 42 T.C. 510">42 T.C. 510, reversed 345 F. 2d 35 (C.A. 4), where two corporations had been liquidated after disposing of a substantial portion of their business assets and where, after the lapse of a period of time, the remaining assets were transferred to a new corporation. The case arose in the difficult area of liquidation-reincorporation, and this Court held that there had been an (F) reorganization. The briefs on this issue were skimpy, and it is obvious that the Court did not have the benefit of a presentation of materials like the one before us. Upon appeal, the Court of Appeals held that there was no reorganization at all on the facts without specifically considering whether the unification of multiple corporations could qualify under (F). We think that our decision in Pridemark was wrong and it will no longer be followed to the extent that it *152 is inconsistent with our conclusion herein.
Petitioner's position is also supported by an alternative holding in Davant v. Commissioner, 366 F. 2d 874 (C.A. 5), modifying 43 T.C. 540">43 T.C. 540, which held that a transaction involving the unification of the *303 businesses of more than one active corporation qualified as a reorganization under both (D) and (F). Like Pridemark, this case arose in the liquidation-reincorporation field, where it was to the Government's advantage to urge that there had been a tax-free reorganization. When the case was before this Court, we had held that there was a (D) reorganization and carefully refrained from characterizing the transaction in relation to (F). The Government's brief on appeal made no effort to support our decision on the ground that there had been an (F) reorganization, and the opinion of the Court of Appeals was rendered without the benefit of any comprehensive analysis of counsel of the matter. When the taxpayer petitioned the Supreme Court for certiorari, the Government's brief in opposition did not undertake in any way to support the conclusion of the Court of Appeals in respect of the applicability of (F), and defended the decision solely on *153 the ground that there had been a (D) reorganization in that case. Certiorari was denied, 386 U.S. 1022">386 U.S. 1022. With all due respect to the Court of Appeals, we do not accept its interpretation of subparagraph (F).
Petitioner also relies heavily upon a ruling of the Internal Revenue Service, Rev. Rul. 58-422, 2 C.B. 145">1958-2 C.B. 145, and contends that it deals with a situation indistinguishable from the present case. Apart from the fact that we are not bound by that ruling, we think it is distinguishable. The facts in that case involve a parent corporation that was to be reincorporated in another State, and at the same time acquire the assets of its two wholly owned subsidiaries. The Service ruled that the reincorporation of the parent would be an (F) reorganization. No such ruling was given in respect of the subsidiaries, and since the subsidiaries or their businesses were always under the same corporate umbrella of the parent, both before and after the reorganization, it is plain that the situation presented in the ruling is not the same as the one before us. 9*154
Finally, petitioner makes two alternative arguments on this issue, one, that there were three separate (F) reorganizations whereby each of the old Stauffer companies merged into Stauffer New Mexico, and, two, that in any event there was at least one (F) reorganization whereby Stauffer California merged into Stauffer New Mexico. We think that neither of these alternatives is sound.
The merger agreement specifically stated that it would not be binding upon any of the constituent corporations, their officers, or stockholders until a copy of the agreement and any other certificates and documents *304 required by law were properly filed and recorded with the proper governmental authority of all four States. Even if Stauffer California complied with the laws of its jurisdiction before Stauffer Illinois and Stauffer New York did so, a finding we cannot make on the state of this record, by the terms of the merger agreement there was no valid merger between any of the corporations *155 until the laws of all the States involved had been complied with. Thus, the three old Stauffer companies merged into Stauffer New Mexico not seriatim but simultaneously. Either all three were parties to the (F) reorganization or none were. The three mergers were interdependent. They cannot be fragmented, nor can one of them be singled out as an (F) reorganization as was possible in the case of the parent corporation in Rev. Rul. 58-422.
We hold that the statutory merger herein, although qualifying as a reorganization under (A), did not satisfy the more rigorous definition in (F) as "a mere change in identity, form, or place of organization." Accordingly, section 381(b)(1) required that the taxable year of the three old Stauffer companies come to an end when they transferred their businesses to the new corporation, and section 381(b)(3) explicitly forbade the carryback of the new corporation's net operating loss to a prior taxable year of any of the old companies.
2. Write-down of Inventory as of September 30, 1959. -- Pursuant to his determination that the merger of the three old Stauffer companies into Stauffer New Mexico was not an (F) reorganization, the Commissioner computed *156 the taxable income of each of the old corporations for the 8-month period from February 1, 1959, the beginning of a new fiscal year for each corporation, to September 30, 1959, the last full day of their tax lives under section 381(b)(1). In computing the cost of goods sold during that period he took the closing September 30, 1959, inventories at book value or cost. Each of the old Stauffer companies had consistently used the lower of cost or market method of valuing inventories, and petitioner now argues that there should be a retroactive downward revision of the inventories as of September 30, 1959, in the aggregate amount of $ 1,311,062 which it is contended, is necessary to reflect a drop in market value below cost as of that date.
A spirited controversy has developed between the parties as to whether "market" value in this context means the taxpayer's reproduction or replacement cost, as urged by the Government, or whether it means "net realizable value," as argued by petitioner. Taking the position in substance that the inventories did not have a fair market value equal to their cost and that the net realizable value was $ 1,311,062 less than cost, petitioner claims that the *157 inventories must be written down by that amount. We need not resolve the controversy between *305 the parties as to which concept of "market" is properly to be applied here, because as we evaluate the evidence before us petitioner has failed to prove that net realizable value of the inventories was less than cost on September 30, 1959.
Petitioner presented no direct evidence as to value on September 30, 1959, and the valuations upon which it relies consist merely of the results of computations made by the accounting firm of Price, Waterhouse & Co. in 1963, which in turn were based in large part upon the facts as they existed on January 31, 1961, the date as of which the actual write-down of inventory was made on the Stauffer books. In our view no such write-down was justified as of September 30, 1959.
The underlying theory of petitioner's position is that Stauffer's tarnished image as the result of unfavorable publicity made its products generally unsalable and that they could not profitably have been sold as of September 30, 1959. 10*158 We think that conclusion is not warranted by the evidence.
The record of Stauffer sales for the month of September 1959 itself goes far to undercut petitioner's position. Although the highly critical statement of the Secretary of Health, Education, and Welfare was issued on September 2, 1959, sales (in units) of Stauffer products for that month were the highest of any month since May of that year, and they in fact exceeded sales for September of the previous year. It is quite true that sales began to fall off shortly thereafter. There was a marked but not critical drop in October, a further sharp reduction in November, but it was not until December and the months of the following year that a devastatingly low level of sales was reached. Meanwhile, the new company continued to manufacture its products at least for some months, and there was no general reduction in prices. Indeed, although the wholesale price of model S-1 was reduced in January 1960 from $ 144.75 to $ 124, it was raised in June 1960 back to $ 144.75, its price on September *159 30, 1959. Also, the $ 80 wholesale price of model L, the second most popular model in October 1959, was raised to $ 99.75 at the beginning of the following month, and its suggested retail price was simultaneously increased from $ 149.50 to $ 199.50.
Moreover, as late as February 12, 1960, Stauffer management submitted financial statements to the Bank of America showing January 31, 1960, inventories at cost without any reduction for any alleged decrease in market value. And such inventories at cost as of January 31, 1960, were still being used in the income tax return filed somewhat more than a month later, on March 15, 1960, on behalf of Stauffer New Mexico. Even as late as August 3, 1960, Bernard H. Stauffer was still *306 highly optimistic not only about being able to sell the inventory on hand, but about resuming profitable operations in the near future. 11*160
We need not discuss the record further in respect of this matter. We have taken it fully into account and have concluded that the net realizable value of the inventories was not less than cost as of September 30, 1959. The fact that unfavorable publicity began in September 1959 is not enough. It was the sort of thing that could conceivably have had but very little permanent effect upon sales or profits. One would hardly have expected the tobacco companies to revalue their inventories of cigarettes below cost after a report of the Surgeon General of the United States pointing out the correlation between cigarette smoking and lung cancer or heart disease. The record establishes here that Stauffer sales held firm in September 1959 and in fact showed an increase. We find that there is no basis upon which to justify a downward revision of inventory values as of September 30, 1959. The fact that a ground for such reduction existed on January 31, 1961, or possibly even at an earlier date, does not warrant a push-back of that date to September 30, 1959.
3. So-called "erroneous assessment" *161 Issue. -- As a result of the conclusion that the merger of the old Stauffer companies into Stauffer New Mexico was not an (F) reorganization, it is undisputed that Stauffer New Mexico was prohibited under section 381(b) (3) from carrying back its fiscal 1961 net operating loss to the fiscal years 1958 and 1959 of any of its predecessors. However, based upon such claimed carryback, Stauffer New Mexico applied for and in fact received a refund of the full amount of taxes paid by Stauffer California for fiscal 1958 ($ 1,481,653 tax plus $ 12,035.89 interest), and a portion of the taxes paid by Stauffer California for fiscal 1959 ($ 263,194 tax plus $ 2,138 interest). Although the claim for refund did not identify Stauffer California as the predecessor taxpayer, it is plain on this record and undisputed by the parties that such taxes were in fact those of Stauffer California that were refunded. Indeed, all of the figures set forth in that claim with respect to the income reported and tax previously determined for the fiscal years 1958 and 1959 related exclusively to Stauffer California. The refund was claimed under the so-called "quickie" refund procedure of section 6411 of the 1954 *162 Code which directs the Secretary or his delegate to make a refund within 90 days of the application for a tentative allowance of a net operating loss carryback subject only to a limited review of such application. Accordingly, if there has been a refund of Stauffer California's 1958 *307 and 1959 taxes based upon a net operating loss carryback deduction to which it was not entitled, there would result a deficiency 12*163 in Stauffer California's 1958 and 1959 taxes 13 which the Commissioner determined herein.
Petitioner contends, however, that if the merger did not qualify as an (F) reorganization, Stauffer New Mexico must be regarded as an entirely different taxpayer from Stauffer California, that Stauffer California's taxes were in effect refunded to a stranger, namely, Stauffer New Mexico, that there was thus no proper refund of Stauffer California's taxes, with the consequence that there can be no deficiency in Stauffer California's 1958 and 1959 taxes based upon such refund. We hold that the point is without merit.
While *164 it is quite true that Stauffer New Mexico cannot be regarded as the same taxpayer as Stauffer California under section 368(a)(1)(F), it was nevertheless the successor to Stauffer California as the result of a statutory merger under section 368(a)(1)(A) and had full standing to apply for and receive a refund of Stauffer California's taxes. Rev. Rul. 54-17, 1 C.B. 160">1954-1 C.B. 160. If such refund were erroneously made, as was the situation in this case, there resulted a deficiency in Stauffer California's taxes (not Stauffer New Mexico's taxes), which the Commissioner was entitled to collect from the ultimate transferee of Stauffer California's assets, namely, the petitioner herein. To be sure, the claim for refund should have identified Stauffer California as the taxpayer, but there was never any doubt that the refund sought and received related to taxes paid by Stauffer California. Stauffer New Mexico was not even in existence during the 2 fiscal years in question, and it is difficult to see how the Commissioner could have determined deficiencies against it in respect of the improper refund. *308 When that refund was made, deficiencies arose in Stauffer California's taxes for its fiscal years *165 1958 and 1959. We hold that the Commissioner proceeded properly in determining the deficiencies and transferee liability herein.
Decisions will be entered for the respondent.
Footnotes
1. Although the record indicates that Stauffer Illinois was incorporated in 1948, there is no clear evidence as to the nature of its activities prior to 1956.↩
2. This inventory issue becomes pertinent only if it is held that the merger of the three old Stauffer companies failed to qualify as an (F) reorganization with the counsequence that closing returns were required to be filed by each of the old companies as of Sept. 30, 1959.↩
1. 732 of these units were manufactured during period from Feb. 1, 1960, to Jan. 31, 1961.↩
3. Other issues presented will be considered hereinafter.↩
4. SEC. 381. CARRYOVERS IN CERTAIN CORPORATE ACQUISITIONS.
(a) General Rule. -- In the case of the acquisition of assets of a corporation by another corporation --
(1) in a distribution to such other corporation to which section 332 (relating to liquidations of subsidiaries) applies, except in a case in which the basis of the assets distributed is determined under section 344(b)(2); or
(2) in a transfer to which section 361 (relating to nonrecognition of gain or loss to corporations) applies, but only if the transfer is in connection with a reorganization described in subparagraph (A), (C), (D) (but only if the requirements of subparagraphs (A) and (B) of section 354(b)(1) are met), or (F) of section 368(a)(1),
the acquiring corporation shall succeed to and take into account, as of the close of the day of distribution or transfer, the items described in subsection (c) of the distributor or transferor corporation, subject to the conditions and limitations specified in subsections (b) and (c).(b) Operating Rules. -- Except in the case of an acquisition in connection with a reorganization described in subparagraph (F) of section 368(a)(1) --
(1) The taxable year of the distributor or transferor corporation shall end on the date of distribution or transfer.
* * * *
(3) The corporation acquiring property in a distribution or transfer described in subsection (a) shall not be entitled to carry back a net operating loss for a taxable year ending after the date of distribution or transfer to a taxable year of the distributor or transferor corporation.↩
5. SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.
(a) Reorganization. --
(1) In General. -- For purposes of parts I and II and this part, the term "reorganization" means --
(A) a statutory merger or consolidation;
(B) the acquisition by one corporation, in exchange solely for all or a part of its voting stock, of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not such acquiring corporation had control immediately before the acquisition);
(C) the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of substantially all of the properties of another corporation, but in determining whether the exchange is solely for stock the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded;
(D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356;
(E) a recapitalization; or
(F) a mere change in identity, form, or place of organization, however effected.↩
6. In fact, the (F) reorganization has come to be identified with the typical case in which a single corporation reincorporates in a different jurisdiction. Cf. Marr v. United States, 268 U.S. 536">268 U.S. 536↩, Paul, Studies in Federal Taxation 82 (Harv. Univ. Press (3d ser.) 1940).
7. It is true that Libson Shops involved the 1939 Code and that the provisions relating to carryover of losses have been changed in the 1954 Code, cf. Maxwell Hardware Co. v. Commissioner, 343 F.2d 713">343 F.2d 713↩ (C.A. 9); but its relevance to the issue before us in respect of the nature of the change effected by combining several active corporations into a single corporation remains unimpaired.
8. Petitioner asserts that the regulations have taken this very situation into account. Sec. 1.1244(d)-3(d) (1), Income Tax Regs. These regulations provide that if common stock is received in an (F) reorganization partly in exchange for stock not meeting the requirements of sec. 1244, only that percentage of common stock received which is determined by the ratio of the basis of the nonqualifying shares given up to the basis of all shares given, will be disqualified as sec. 1244 stock. Thus, petitioner claims, not only is sec. 1244 not inconsistent with a multiple reincorporation (F) reorganization, but the regulations have in fact anticipated and provided for this very possibility. But a careful examination of the regulations discloses that such is not the case.
An identical counterpart to this regulation deals with nonqualifying stock given up in an (E) reorganization, a recapitalization, which plainly involves only one corporation. Sec. 1.1244(d)-3(c) (2), Income Tax Regs. What the regulations are dealing with here, in both the (E) and the (F) reorganization situations, is the case in which a single corporation has more than one class of stock, and stock of a disqualified class (e.g., any class which cannot be considered common stock) is given up by the taxpayer, along with qualified stock, in exchange for common stock either of the same corporation (the (E) reorganization) or the successor corporation (in an (F) reorganization). See sec. 1.1244(d)-3(c)(3), examples (i) and (ii↩), Income Tax Regs.
9. Also distinguishable is our recent decision in Dunlap & Associates, Inc., 47 T.C. 542">47 T.C. 542, where the reincorporation of a parent corporation in another State was held to be an (F) reorganization, a result that was unaffected by the parent's subsequent acquisition of outstanding minority interests in two subsidiary corporations through an exchange of stock.
10. To the extent that this position is also based on Stauffer's increased and aggressive competition, beginning in 1958, it is without any merit. In the face of such competition the three old Stauffer companies realized an aggregate net profit of $ 1,492,077 for the 8-month period ending Sept. 30, 1959.
11. Of course, objective facts as they existed on the pertinent date or dates rather than the beliefs of management may be controlling, cf. C-O Two Fire Equipment Co. v. Commissioner, 219 F. 2d 57 (C.A. 3), reversing 22 T.C. 124">22 T.C. 124, but such views, particularly those of top management that has had extensive experience in respect of the product, appear to be relevant in arriving at objective facts relating to salability of the product.
12. SEC. 6211. DEFINITION OF A DEFICIENCY.
(a) In General. -- For purposes of this title in the case of income, estate, and gift taxes, imposed by subtitles A and B, the term "deficiency" means the amount by which the tax imposed by subtitles A or B exceeds the excess of --
(1) the sum of
(A) the amount shown as the tax by the taxpayer upon his return, if a return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus
(B) the amounts previously assessed (or collected without assessment) as a deficiency, over --
(2) the amount of rebates, as defined in subsection (b) (2), made.
(b) Rules for Application of Subsection (a). -- For purposes of this section --
* * * *
(2) The term "rebate" means so much of an abatement, credit, refund, or other repayment, as was made on the ground that the tax imposed by subtitles A or B was less than the excess of the amount specified in subsection (a) (1) over the rebates previously made.↩
13. Although the deficiency determined for fiscal 1958 was in the full amount of the refund taxes for that year ($ 1,481,653.05), the deficiency determined for fiscal 1959 ($ 213,472.25) was less than the full amount of the refunded taxes for fiscal 1959 because a $ 49,721.79 deficiency assessment for the same year in relation to another matter had previously been paid by Bernard H. Stauffer as transferee.↩