Supplemental Opinion on Denial of Rehearing delivered October 14, 1974
1. Taxation — deductions for losses — continuity of business- enterprise. — There is a continuity of business enterprise with respect to the right of a new corporation to deduct from post-merger income the economic loss of its constituent corporation when the income producing business has not been altered, enlarged or materially affected by the merger.
2. Taxation — deductions for losses — scope of statute. — Surviving corporation could not claim the operating loss carryover of the submerged corporation as an income tax deduction where it failed to bring itself within the statutory provisions authorizing it.
John A. Fogleman, Justice.Appellee, on petition for rehearing, aptly summarizes its very forceful argument thereon in stating its point to be relied on thus:
A rehearing should be granted and the holding of the lower court affirmed because Lisbon Shops v. Koehler, and the cases following that decision hold that the losses of a loss corporation, which has merged into another corporation, may be carried over and deducted, for income tax purposes, if the “bundle of assets” of the loss corporation produces profits in post merger years from a continuation of the business that the loss corporation was engaged in.
In its brief, great reliance is placed by appellee upon language of the opinion in Lisbon v. Koehler, 353 U.S. 382, 77 S. Ct. 990, 1 L. Ed. 2d 924 (1957), partly because some of the reasoning in that opinion was relied upon by the North Carolina Supreme Court in Good Will Distributors (Northern) v. Currie, 251 N.C. 120, 110 S.E. 2d 880 (1959). In Good Will, the concept of “continuity of business enterprise” was applied in determining when the “operating loss carryover” of a submerged corporation could be taken by the surviving corporation as an income tax deduction. Appellant also argues, however, that both Newmarket Manufacturing Co. v. U.S., 233 F. 2d 493 (1 Cir. 1956) and Industrial Cotton Mills Co. v. Commissioner, 61 F. 2d 291 (4 Cir. 1932) discussed by the Good Will court and by us in our original opinion can be distinguished and that we should allow B. C. Land Company to take the deduction of the “operating loss carryover” of B. C. Gin Co. by following other progeny of Koehler, some of which had been cited by the parties in Bracy Development Company v. Milam, 252 Ark. 268, 478 S.W. 2d 765. Appellee, in its original brief, first argued that the “continuity of business enterprise” doctrine mandated the allowance of the deduction because premerger activities of B. C. Land Co. and B. C. Gin Co. were related activities of a common farming enterprise. Appellee also argued, however, that not only was the business of the two merged corporations substantially identical but the “continuity of business enterprise” theory required that the deduction be allowed if the income against which the premerger loss was offset was substantially the same operation which suffered the loss. While our emphasis in the original opinion was directed toward the first argument, we rejected both and reject them now. Furthermore, we do not agree with appellee that both Koehler and Good Will would have been decided favorably to the taxpayer if the same operations which had been conducted by loss corporations had generated profits in postmerger years to offset the losses claimed. And lastly, we do not consider that we should look only to the ginning operation to see whether that business was altered, enlarged or materially affected by the merger, as appellee suggests.
In denying the petition for rehearing we need not indulge in any attempt to distinguish the cases cited in appellee’s brief or to analyze the rationale of Koehler. This is because our decided preference for the North Carolina treatment of the problem expressed in Bracy foreclosed those considerations. As we said in our original opinion in the instant case, our result was governed by what we said in Bracy. We did not say that it was governed by the result in Bracy. There we held, substantially, that the deduction was allowable because of the coexistence of four standards:
1. Common stock ownerships prior to merger.
2. The merged corporation and the survivor were engaged in the same type, if not identical, business.
3. The deduction would have been available to the merged corporation.
4. The business of the survivor was not altered, enlarged or affected by the merger; it constituted, or at least included a continuation of the business enterprise of the merged corporation on a much sounder financial basis.
We did not say all four of these standards must be met in every case; however, we did take the position that the “separate taxable entity” theory followed by the Wisconsin courts would be applicable in a proper case and that the “continuity of business enterprise” theory would be followed in a proper case. We applied our interpretation of the North Carolina cases both in our original opinion and in Bracy. Our reexamination of this interpretation leads us to the conclusion that it was correct. Because of our deliberate choice in Bracy to follow the treatment of the question by the North Carolina courts, we have confined our re-examination to the decisions of those courts.
In the principal case (Good Will) the rule was stated thus:
Where there has been a merger of corporations, the resulting corporation may not deduct from its post-merger net income the pre-merger economic loss of its constituent corporations unless there is a “continuity of business enterprise” as above defined.
The argument between appellee and appellant arises from differences as to how “continuity of business enterprise” was “above defined.” The Good Will court said that the expression had a definite and well-defined meaning, i.e.:
There is a continuity of business enterprise when the income producing business has not been altered, enlarged or materially affected by the merger.
The North Carolina court then illustrated by reference to two cases. In the first (Newmarket Manufacturing Co. v. U.S., supra) the court said that, in substance, there was no change in business, only a change in name. The surviving corporation, prior to the merger, owned no property (except for the proceeds of the issuance of its entire capital stock to the subsequently merged manufacturing corporation) and engaged in no business. Consequently, said the North Carolina court, the income producing business was unchanged by the merger.
In the other case (Industrial Mills) a manufacturing corporation on the brink of financial disaster was merged into a holding company organized to rescue the first corporation by inducing its creditors to accept stock. Premerger losses of the merged corporation were allowed as a deduction. The North Carolina court quoted from this case as follows:
If it had owned any business or any property other than the stock and obligations of the constituent corporation, there would be reason for denying to the corporation resulting from the merger the right to deduct such loss from its income.
Our interpretation of Good Will and our holding that the North Carolina rule would not permit the deduction of B. C. Gin Company’s operating losses are clearly sustained by Holly Farms Poultry Industries, Inc. v. Clayton, 9 N.C. App. 345, 176 S.E. 2d 367 (1970), cited in Bracy but not in our original opinion in this case. Holly Farms was decided in reliance upon Good Will and certiorari was denied by the North Carolina Supreme Court. In order that the effect of that case and the proper application of the North Carolina rule be clearly understood, we fully state our analysis of the opinion of the North Carolina Court of Appeals, viz:
Holly Farms, a N.C. corporation, carried on an integrated poultry operation and was the parent of a large number of separate corporate entities, all of which were engaged in the poultry industry or in a business directly connected therewith. The purpose was to so operate that one corporation could manage and control the production of poultry from the breeder hens through the hatchery, feed mills, broiler farms, feed out operations, processing plants, and transportation to retail outlets. Holly Farms acquired, either by direct merger into it or by merger into a wholly-owned subsidiary and then into it, 32 corporations. Among them were:
Mocksville Feed* Blue Ridge
Lovette Poultry* Davie Poultry*
Lovette Feed
Blue Ridge and Lovette Feed were merged into Lovette Poultry, which was later merged into Mocksville Feed. Still later Davie Poultry was also merged into Mocksville Feed.
Prior to merger, Lovette Poultry had an economic net loss of over $600,000, of which approximately $100,-000 was attributable to Lovette Feed. The premerger businesses conducted by those corporations (primarily in two counties) were:
Mocksville Feed — manufacture of feed, principally poultry feed, 90% of which was sold through Lovette Poultry and Davie.
Lovette Poultry — a feed out operation by furnishing feed (Mocksville) to farmers to enable them to grow chickens to a weight suitable for the processing plant.
Davie Poultry — in addition to a business similar to that of Lovette Poultry, an experimental farm for the benefit of Mocksville Feed by which Mocksville could conduct experiments with new formulae and feeds.
Subsequent to the mergers the same type and kind of businesses were carried on, in the same manner and with the same management, officers and personnel and the mergers did not effect any change in administration, operation or ownership of either of the three corporations. On its income tax return for the year of the mergers and the succeeding year Mocksville Peed claimed the net operating loss of Lovette as a deduction. Mocksville also carried forward and claimed the net operating loss of Davie.
The court of appeals reversed the trial court’s holding that there was a continuity of business enterprise and that Mocksville was, for this reason, entitled to the deduction. It held:
1. The allowance of a deduction is a matter of legislative grace.
2. One claiming the deduction must bring himself within the provisions of the statute authorizing it.
3. Generally the deduction may be taken only by the taxpayer to whom it accrues.
4. The facts did not support the trial court's conclusion, viz:
a. Before merger Mocksville (B. C. Land Co.) had a net worth of $2,057,204.94 and was engaged in the manufacture of feeds. After the merger of Lovett Poultry (B. C. Gin Co.) it had a net worth of $3,017,-414.78, having added Lovette s net worth of $960,-209.84, and was engaged not only in the manufacture of feed (farming the land it owned) but was also engaged in the business of feeding out chickens (ginning cotton); thus, the income producing business was substantially enlarged and materially affected by the increase.
b. The subsequent merger of Davie Poultry (B. C. Gin Co.) into Mocksville Feed further increased the net worth of Mocksville (B. C. Land Co.) by $76,-936.66, the net worth of Davie, and added an experimental farm and another feed-out operation (cotton ginning) to the combined operation.
c. Each merger both substantially enlarged and materially affected the income producing business of the surviving corporation (B. C. Land Co.).
5.To find any continuity of business enterprises would require that the three businesses be considered as though they had always been one or that the mergers be ignored.
6. Each merger so substantially enlarged and materially affected the income producing business that there was no continuity of business enterprise within the definition laid down in Good Will.
7. The fact that there was a vertical merger, i.e., the several merged corporations were doing different jobs in one continuous chain of processing (in Holly Farms and here) and the merger in Good Will was horizontal, i.e., each of the corporations involved was doing basically the same job, is a distinction without a difference.
8. The fact that the mergers were made in pursuance to an overall plan to bring into being an integrated operation, and not for tax avoidance purposes is not determinative of the question.
(Parenthetical matter has been inserted in order to clearly indicate the close analogy.)
This is the only “post-Cotw/ Will" decision we have found in North Carolina. We find no case reaching a different result in applying the North Carolina rule. Clearly, the application of the North Carolina rule we used in Bracy mandates the result we reached and to which we adhere.
Holt, J., dissents.AU of these were wholly owned subsidiaries of Holly Farms and had identical officers and directors.