Internal Revenue Service
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 Rev. Rul. 77-67

1977-1 C.B. 33

Section 111
Section 334

IRS Headnote

Recovery of previously deducted amounts; subsidiary liquidated into parent. The tax benefit rule described in Rev. Rul. 74-396 is applicable to liquidations under section 336 of the Code; the position of the Service with respect to South Lake Farms, Inc. is explained.

Full Text

Rev. Rul. 77-67

As a result of the acquiescence in South Lake Farms, Inc., 36 T.C. 1027 (1961), acq., 1975-1 C.B. 2, aff'd, 324 F.2d 837 (9th Cir. 1963), the Internal Revenue Service has been asked to clarify an apparent conflict in its position with regard to the applicability of the so-called "tax benefit rule" to corporate liquidations under section 336 of the Internal Revenue Code of 1954 as provided in Rev. Rul. 74-396, 1974-2 C.B. 106.

In South Lake Farms, Inc. the new corporation purchased all the outstanding stock of South Lake Farms, Inc. (old corporation) and subsequently liquidated it pursuant to sections 332, 334(b)(2), and 336 of the Code. Prior to its liquidation the old corporation had incurred and deducted under its accrual method of accounting various expenses for the planting and growing of a cotton crop and the preparation of land for the planting of a barley crop. Neither the growing crop nor the land preparation expenses were inventoried for its last full fiscal year and the short year prior to liquidation.

On the distribution of assets the new corporation allocated a portion of its stock basis in the old corporation to the unharvested cotton crop and land preparation pursuant to section 334(b)(2) of the Code. The new corporation harvested the cotton crop and planted and harvested the barley crop deducting in both situations the allocated stock basis and its additional expenses against the sales proceeds.

The Internal Revenue Service in the Tax Court of the United States, argued that the value of the cotton crop and land preparation should be included in the income of the old corporation in its final return in order to clearly reflect the income of the old corporation within the meaning of section 446(b) of the Code. Alternatively, the Service argued that the provisions of section 482 should be applied to increase the taxable income of the old corporation in its final return representing the expenses attributable to the cotton crop and land preparations. Both of these positions were rejected by the Tax Court.

On appeal, the decision of the Tax Court was affirmed despite the additional contention of the Service that section 446(b) of the Code should require the inclusion of the crop and land preparation deductions in the income of the old corporation since it received a "tax benefit" for these expenses through deductions in taxable years prior to liquidation.

In Rev. Rul. 74-396, 1974-2 C.B. 106, the tax benefit rule was applied in a liquidation transaction pursuant to sections 332 and 334(b)(2) of the Code to incidental supplies deducted in a year prior to liquidation but not consumed at the time of liquidation. The portion of the purchase price allocated to the supplies by the purchasing corporation under section 334(b)(2), and determined not to be in excess of the cost of such supplies, was included in the income of the liquidating corporation pursuant to section 61 in the year of liquidation. Furthermore, the application of the tax benefit rule to liquidations under section 336 would serve to neutralize tax considerations in choosing whether to liquidate under section 336 or section 337, where the tax benefit rule has been determined to be applicable. Additionally, the interpretation of "recovery" given by the Circuit Court of Appeals in South Lake Farms, Inc. was held to be erroneous in Rev. Rul. 74-396 and by the Tax Court in Tennessee Carolina Transportation, Inc., 65 T.C. 440, 447 (1975), appeal docketed, No. 76-2496 (6th Cir., Aug. 4, 1976).

The principal issues involved in the Tax Court's consideration of South Lake Farms, Inc. concerned sections 446(b) and 482 of the Code and the acquiescence refers only to these issues without any comment as to the applicability of the tax benefit rule or the validity of Rev. Rul. 74-396. Only on appeal was the issue of the applicability of the tax benefit rule raised by the Service.

Accordingly, the acquiescence in the Tax Court decision in South Lake Farms, Inc. does not conflict with Rev. Rul. 74-396 because the tax benefit rule was not an issue in that case. Because of the misunderstanding caused by the acquiescence, and because the Service no longer agrees with the decision made by the Tax Court, the acquiescence is withdrawn and nonacquiescence is substituted therefor. See page of this Bulletin.

For taxable years beginning after December 31, 1976, see section 207(c) of the Tax Reform Act of 1976, Pub. L. No. 94-455, 94th Cong., 2d Sess. (October 4, 1976) [1976-3 C.B. (Vol. 1) 15], which added section 447 to the Code. Section 447 requires certain corporations engaged in farming to use the accrual method of accounting and to capitalize pre-productive expenses.